Roll an Estate’s Pension Plan or IRA to the Heirs

By Margaret Atkins Munro and Kathryn A. Murphy from Estate and Trust Administration For Dummies

2 of 7 in Series: The Essentials of Avoiding Common Trust and Estate Mistakes

If you are administering an estate with a pension plan or IRA, roll the account to the estate heirs. Do not take a lump sum distribution on the pension plan or IRA for the estate, because the estate will then owe income and estate taxes on the value of the account. Roll the estate’s traditional IRAs, 401(k), 403(b), and 457 plans to the heirs to avoid expensive income and estate taxes.

When you’re trying to figure out exactly how much the estate owns, you may be tempted to liquidate everything into cash. Although this thinking may work on some assets, don’t do it with any sort of pension plan or IRA.

As soon as you cash out that deferred income retirement plan, whether it’s a traditional IRA, a 401(k) plan (or its public and nonprofit sector equivalents 403(b) and 457 plans), the estate now owes income taxes on every penny of it that the decedent hadn’t already paid tax on.

In addition to the income tax bite, you also owe estate taxes on the value of the account as of the date of death (or alternate valuation date, if you make the election). For an estate that holds a large IRA; between the income and estate taxes paid, the effective tax rate can be almost 97 percent.

Far better than automatically taking a lump sum distribution is figuring out if you can roll the account over to the heirs. If the decedent designated a surviving spouse or children as beneficiary, then you have no problem. Using the rollover technique, no one owes any income taxes until the new beneficiaries begin to take distributions.

Additionally, you can spread those distributions out over a number of years, lessening the tax bracket each distribution is taxed at. Of course, if you have a taxable estate, the value of the account at the date of death is still included for estate tax purposes.

Seek competent tax advice as soon as you discover a large IRA, because there are time limits imposed on retitling it. If the asset in question is a pension, check the plan documents to determine what options are available to the beneficiary.