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Gary S. Williams: Managing inherited assets takes diligence

Your options in managing assets that you inherit from a loved one’s qualified retirement plan may depend on the type of plan in question — for example, 401(k)/403(b) plan or IRA — and your relationship to the deceased.

• Employer-sponsored plans: Federal laws require that a spouse be the primary beneficiary unless he or she waives that right in writing. When retirement plan assets are left intact within an estate, spousal beneficiaries may inherit the money without paying federal estate or income taxes. After age 70 1/2, the surviving spouse must begin required minimum distributions (RMDs) based on his or her life expectancy. The RMDs are taxed as ordinary income.

With non-spousal beneficiaries, the plan’s rules may determine the beneficiary’s options. Some plans require non-spousal beneficiaries to cash out retirement plan bequests between one and five years after the account owner’s death. In contrast, other employer plans may offer non-spousal beneficiaries the option of completing a trustee-to-trustee transfer from an employer-sponsored plan to an IRA established for this purpose and subsequently taking annual distributions based on the beneficiary’s life expectancy. Regardless of the method that you follow, distributions taken by heirs are taxed as ordinary income.

It is critical that beneficiaries determine the rules of the deceased’s retirement plan and consult a financial adviser who can make sure that a bequest from an employer-sponsored retirement plan is managed properly, thereby avoiding unnecessary tax payments.

• IRAs: With an IRA, spousal beneficiaries may designate themselves as the account owner and treat an inherited IRA as their own. This means a surviving spouse can transfer the assets to an existing IRA or to an employer-sponsored plan. These transfers typically do not trigger tax payments as long as a spouse follows the rules for trustee-to-trustee transfers. After age 70 1/2, a spousal beneficiary is mandated to take annual RMDs, which are based on the surviving spouse’s life expectancy and are taxed as ordinary income.

Non-spousal beneficiaries cannot transfer assets within an inherited IRA to an existing IRA. Instead, they have two options: They may take all distributions within five years of the original account owner’s death or take annual distributions determined by the life expectancy of either the beneficiary or the decedent, whichever is longer.

Because determining the tax status of inherited assets can be complicated, you may want to consult an estate-planning attorney or a financial adviser to answer any questions you may have.

This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Gary S. Williams, CFP, CRPC, AIF, president of Williams Asset Management in Columbia. He is an investment adviser representative with, and offers securities & advisory services through, Commonwealth Financial Network, member FINRA/SIPC, a Registered Investment Adviser. He can be reached at (410) 740-0220 or Gary@WilliamsAsset.com.