If my 401(k) has a balance when I die, and it passes to my estate, are there any taxes or penalties assessed before it becomes part of the estate? Or is it simply liquidated like any other asset would be?
Your estate will owe the taxes. Just went through some retirement seminars with my employer, this was a common question.
If you set up a beneficiary for your tax-advantaged retirement account, the beneficiary can withdraw the money and pay taxes on it gradually rather than in one big lump (at a higher rate).
A spouse can simply use it as if it were their own IRA and need not take the required minimum distribution until they reach 70-1/2 years old. A non-spouse who inherits has to continue taking the RMD but can do it based on their age and life expectancy, not that of the original owner. Taxes need only be paid on the amount distributed.
Correct! When my mother died, I had the option to take it over my lifespan, or as an immediate distribution, or (I think) in roughly equal distributions over a comparatively short time e.g. 5 years (but I may be misremembering that).
If you don’t have a beneficiary designated, I’m not sure what happens. When my mother died, one of the banks tried to claim they didn’t have valid beneficiary designations on file, and were going to have to pay it out to the estate. The result would have been that we each got 1/4 of it, same as Mom had designated, but I think this would have impacted the estate value and therefore inheritance taxes, AND it might have been taxable income to the estate. We persuaded the bank that they did in fact have valid paperwork on file - I honestly don’t recall what the supposed issue was - so it was a non-issue, and I take a RMD of about 700 bucks a year now.
Aha - found a cite. From that site, it sounds like the 401(k) would have to be liquidated and paid out to the estate, and taxes would be due on that right away.
Another interesting point: If there is a designated beneficiary, then the money may be safe from the decedent’s creditors.. If no beneficiary, it seems it would be dumped into the estate and used to pay debts.
So kiddies, the take-away lesson is make sure all the accounts have beneficiaries even if they’re the same ones you’d want to get the money even w/o the designation (as with us 4 kids).
Your state may tax the proceeds, though.