Many of us do an excellent job of planning for the future, and for future generations. We have a monthly spending plan, limited credit balances, an emergency fund for “just in case”, a growing savings account, and a plan to leave our assets to future generations. One asset that many of us have is a 401(k) retirement account, and the federal government recently changed its laws governing a 401(k) retirement account’s passage to future generations.
A 401(k) plan is a retirement savings plan that is funded by employee contributions and (often) matching contributions from the employer. The major attraction of these plans is that the contributions are taken from pre-tax salary, and the funds grow tax-free until withdrawn. Also, the plans are (to some extent) self-directed, and they are portable. Both for-profit and many types of tax-exempt organizations can establish these plans for their employees.
On August 17, 2006, President George Bush signed a new 907 page pension law which included a provision allowing anyone to inherit a 401(k) retirement account nest egg without immediate tax consequences. This little-noticed provision in the law is the first time anyone besides spouses will be allowed to inherit a 401(k) retirement account without immediately paying taxes on the windfall. Previously, a spouse could inherit a 401(k) retirement account and put the money into his or her own retirement savings account without penalty, but anyone else, including children, were required to withdraw all funds from the account and pay taxes on the income within a matter of months. Under the new provision, any other heir will be able to roll the 401(k) into their own Individual Retirement Account and not pay taxes on the income immediately. This is a big shift. Previously, the windfall of an inherited 401(k) retirement account could have forced some survivors into a higher tax bracket. This change could save many heirs tens of thousands of dollars in taxes.
How does this change affect you? Well, it depends upon where you are in your own estate planning and your asset goals. What do you do when something out of your control changes your future plans? Revisit and re-evaluate! Take some time to go back over your estate plan and see how these changes may affect you. Contact your financial planner for advice, and discuss what these changes may mean for you and your family’s future.