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That's true after you die as well. If your heirs can keep their hands off the money, there are strategies to help it grow -- and mistakes that will make it shrink fast. The scenarios:
Scenario 1: You're in a federally recognized marriage. Your surviving spouse can roll your 401k money into his own individual retirement account, said Roger Stinnett, a tax and financial planning manager for City National Bank. That's good, Stinnett said, because then he can opt to delay withdrawals until the year after he turns 70 1/2. (Remember, the longer the money remains tax-protected, the better.)
But your surviving spouse can still blow a good thing. If he accepts the money himself, rather than arranging a direct transfer into an IRA, your employer has to withhold 20% for taxes. And if he spends the money, it all becomes taxable, and taxes can eat up one-quarter or more of the total.
Scenario 2: You're not in a federally recognized marriage. In the bad old days, beneficiaries other than surviving spouses couldn't roll inherited 401k money into IRAs. They typically had to withdraw the money within five years, paying income taxes on the proceeds.
Fortunately, in 2006 then-President George W. Bush signed a pension-protection law that changed that. Now children, unmarried partners and other nonspouse beneficiaries can roll 401k money into what's called an inherited IRA, set up for just this purpose. Nonspouse beneficiaries still have to take withdrawals from these IRAs, Stinnett said, but the withdrawals are based on the beneficiaries' life expectancies. The younger they are, the smaller the required withdrawal and the longer the bulk of the money can remain tax-protected.
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- There's a deadline. The money has to be moved to the inherited IRA before the last day of the year after the year in which the account owner died. So if you die in 2009, your heirs would have to transfer your money to an inherited IRA by Dec. 31, 2010. If your heirs failed to make the deadline, they could still transfer the cash to an IRA, but they'd have to withdraw the money and pay taxes on it under the old 401k guidelines, which typically means within five years.
- The money should be transferred directly. As with surviving-spouse transfers, employers will withhold 20% of the money if beneficiaries receive it directly. They should arrange a direct transfer from the 401k into a properly titled inherited IRA. (If there are any questions about titling, consult a tax professional.)
You won't have much control over what your heirs do once you're gone, of course. But if you care about what happens to them and your money, you might want to discuss these issues with them and find a tax pro or an estate-planning attorney who can advise them when you're gone.
Updated Nov. 23, 2009
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