If you’re like most people, you probably don’t think too much about what would happen to your retirement account if you died. But it’s actually a pretty important question, especially if you live in Texas.
Inheriting a retirement account can be a significant financial asset, but it also comes with several complexities and tax implications.
As a resident of Texas, understanding the state’s laws and regulations surrounding inherited retirement accounts is crucial. This includes a number of diverse topics, such as the benefits of qualified retirement plans, the different types of retirement accounts, required minimum distribution rules, and tax implications related to inherited retirement accounts.
Benefits of Qualified Retirement Plans
Ability to Save Tax-Free for Retirement
One of the primary benefits of a qualified retirement plan, such as a 401(k) or 403(b), is the ability to save money for retirement on a tax-deferred basis. This means that you can contribute pre-tax dollars to your retirement account, reducing your taxable income for the year. In addition, any investment gains on the money in your retirement account are also tax-free until you withdraw the money in retirement. This can help to maximize your retirement savings and reduce your tax burden during your working years.
Ability to Designate a Beneficiary
There are many benefits to inheriting a retirement account, including the ability to grow your nest egg and provide for your family in the event of your death.
With a retirement account, you can also leave a financial legacy for your loved ones. This is one of the primary benefits of retirement accounts. The account owner can name a beneficiary, which can help to ensure that the money goes to the intended person.
Retirement accounts are generally protected from creditors in the event of bankruptcy or other financial difficulties. This means that your retirement savings are typically safe from being seized to pay off debts or other obligations.
Many employers offer matching contributions to their employees’ retirement accounts. This means that if you contribute a certain amount to your retirement account, your employer will match that contribution up to a certain percentage of your salary. This is essentially free money that can help to boost your retirement savings.
Common Types of Retirement Accounts
There are several common types of retirement accounts that individuals can establish and contribute to during their working years. Here are some of the most common types of retirement accounts:
A traditional IRA can be inherited by a spouse or non-spouse beneficiary. If the beneficiary is a spouse, they can roll the IRA over into their own name and treat it as their own. If the beneficiary is a non-spouse, they can either cash out the IRA (taxes will be owed on the withdrawal) or roll it over into an Inherited IRA (a special type of account with its own set of rules).
A Roth IRA can only be inherited by a spouse. If the beneficiary is a spouse, they can roll the IRA over into their own name and treat it as their own. If the beneficiary is not a spouse, the Roth IRA must be cashed out and taxes will be owed on the withdrawal.
A 401(k) can be inherited by a spouse or non-spouse beneficiary. If the beneficiary is a spouse, they can roll the 401(k) over into their own name and treat it as their own. If the beneficiary is a non-spouse, they have the option to cash out the 401(k) (taxes will be owed on the withdrawal) or leave it in the account (the account will be subject to required minimum distributions).
A 403(b) is a type of retirement account that is similar to a 401(k) but is available to employees of certain tax-exempt organizations and public schools. A 403(b) can be inherited by a spouse or non-spouse beneficiary. If the beneficiary is a spouse, they can roll the 403(b) over into their own name and treat it as their own. If the beneficiary is a non-spouse, they have the option to cash out the 403(b) (taxes will be owed on the withdrawal) or leave it in the account (the account will be subject to required minimum distributions). The rules surrounding inherited 403(b) accounts can be complex, and it’s a good idea to consult with a financial advisor or tax professional if you inherit a 403(b) account.
What is an Inherited Retirement Account?
An inherited retirement account refers to any type of retirement account that is passed down to a beneficiary after the original owner of the account passes away. This can include Individual Retirement Accounts (IRAs), 401(k)s, 403(b)s, and other types of retirement accounts.
The term “inherited retirement account” is used to note the special rules that apply to accounts that are inherited vs. those that an account holder sets up themselves.
The rules governing inherited retirement accounts can vary depending on the type of account and the relationship between the original account owner and the beneficiary. In general, however, an inherited retirement account allows the beneficiary to continue to benefit from the tax-deferred growth of the account, while also allowing them to take distributions from the account over time.
Required Minimum Distributions
The required minimum distribution (“RMD”) rules for inherited retirement accounts can be different than those for an account that you have established yourself.
The RMD rules for inherited retirement accounts can be different than those for an account that you have established yourself because the IRS has different rules depending on who the beneficiary of the account is and their relationship to the original account owner.
In general, when you establish a retirement account such as an IRA or 401(k), you must begin taking RMDs when you reach a certain age, which is currently 72 years old for traditional IRAs and 401(k)s (as of 2021). The amount of the RMD is based on the account balance and your life expectancy.
However, when you inherit a retirement account, the RMD rules can be different depending on whether you are a spouse, non-spouse beneficiary, or a minor child. For example:
- Spousal beneficiaries: A surviving spouse who inherits a retirement account can either roll the account over into their own name or treat it as an inherited IRA. If the account is rolled over, the spouse will not be required to take RMDs until they reach age 72. If the account is treated as an inherited IRA, the spouse can defer RMDs until the year in which the original account owner would have reached age 72, but they must take RMDs based on their own life expectancy starting in that year.
- Non-spousal beneficiaries: A non-spouse beneficiary who inherits a retirement account must take RMDs over their own life expectancy or within 10 years of the original account owner’s death, depending on certain factors.
- Minor children: If the beneficiary of an inherited retirement account is a minor child, different RMD rules may apply until the child reaches the age of majority.
These are just a few examples, and the rules for inherited retirement accounts can be complex and depend on a variety of factors.
How are Retirement Accounts Taxed?
The tax treatment of distributions from inherited retirement accounts can depend on the age of the original account owner at the time of their death and the relationship between the original account owner and the beneficiary.
If you’re one of the many Texans who have inherited a retirement account, you may be wondering how it will be taxed.
The state of Texas does not have an income tax. Thus, retirement accounts are not subject to state tax.
At the Federal level, retirement account assets can grow tax-deferred. This means that you will not have to pay taxes on the account until you withdraw the money during retirement.
In general, any money that you withdraw from an inherited retirement account will be taxed as income at the Federal level. However, there are a few exceptions. If the account was set up as a Roth IRA, then the money can be withdrawn tax-free. Additionally, if you’re a beneficiary of a deceased spouse’s retirement account, you can often roll the money over into your own retirement account and avoid paying taxes on it. There are also rules for avoiding tax by transferring the account to charity.
Additional Tax on Retirement Account Distributions
There may be an additional tax due if you take an early distribution. Distributees usually have to pay a 10% early withdrawal penalty on any money they take out of the account before reaching the age of 59 1/2.
There are some exceptions to these rules, however. For example, if your spouse is the primary beneficiary of your retirement account, they may be able to take withdrawals without paying the early withdrawal penalty. There are other exceptions for first-time home purchases, etc.
So if you’re thinking about leaving your retirement account to someone other than your spouse, it’s important to understand the rules around inherited retirement accounts.
Inherited retirement accounts come with several benefits, including tax-free savings, the ability to designate a beneficiary, creditor protection, and employer contributions. However, the required minimum distribution rules for inherited accounts can differ from those of accounts established by the owner. Understanding the tax implications and seeking advice from a financial advisor or tax professional can help ensure that the account is managed correctly.
Hire an Experienced Estate Attorney
You’ve recently inherited a retirement account from a loved one who resided in Texas. You may be wondering if you need to hire an experienced attorney to help you with this new account. The answer is: it depends.
If the account is simple and you feel comfortable managing it yourself, then you probably don’t need to hire an attorney. However, if the account is complex or you’re unsure about how to manage it, then it might be a good idea to consult with an attorney who specializes in inherited retirement accounts.
An experienced attorney can help you understand the rules and regulations surrounding inherited retirement accounts, as well as assist with any tax implications that may arise. They can also help ensure that the account is managed in a way that is beneficial to you and your family.
If you decide to hire an attorney, be sure to shop around and find one that you feel comfortable working with. Ask for referrals from friends or family, or consult with your financial advisor. Once you’ve found an attorney that you feel good about, schedule a consultation to discuss your specific needs and concerns. (281) 219-9090.
Our Houston Probate Attorneys provide a full range of probate services to our clients, including helping with retirement accounts. Affordable rates, fixed fees, and payment plans are available. We provide step-by-step instructions, guidance, checklists, and more for completing the probate process. We have years of combined experience we can use to support and guide you with probate and estate matters. Call us today for a FREE attorney consultation.
The content of this website is for informational purposes only and should not be construed as legal advice. The information presented may not apply to your situation and should not be acted upon without consulting a qualified probate attorney. We encourage you to seek the advice of a competent attorney with any legal questions you may have.