What Are the Tax Advantages of a Living Trust?

If your loved one passes away and you are the beneficiary of their retirement account (such as a 401(k) or an IRA) you can take ownership of the account by presenting the original certificate of the deceased to the company or the bank where the account is held. If you are a surviving spouse, the tax implications will be very different as opposed to other types of beneficiaries.

Surviving Spouse Inheriting a 401(k) or IRA and the Associated Tax Consequences

The surviving spouse has a lot of flexibility with what they can do with the 401(k) or IRA account. The choices they can make include:

Rolling over the retirement account into the surviving spouse’s retirement account.

In some cases, the surviving spouse will elect the 401(k) or the IRA into their retirement account. In this case, the income tax associated with a 401(k) and IRA will always be deferred until the surviving spouse makes an account withdrawal. Moreover, the remaining spouse will use their life expectancy to take the distribution. The remaining spouse will, therefore, choose who is eligible to receive the account after the spouse dies.

Choosing to use the account as the deceased spouse’s account.

The benefits of this account work in a limited situation where the spouse is under 59 and the dead partner is over 70. In this case, the spouse may choose to defer taking the withdrawal amount until the deceased time for escaping the penalty is over. If you withdraw the money early enough, you will attract a 10 percent penalty. Once the surviving spouse attains the age of 59, the account can be rolled over to the remaining spouse’s account. While the account is considered as the account of the deceased, the remaining spouse should receive the amount if they die before attaining the age of 55.

Funding the account into the A or B trust established in the said plan.

If the 401(k) or IRA becomes part of the deceased spouse’s trust due to the disclaimer by the surviving spouse or the beneficiary designation, then the taxes will differ until other spouse makes the first withdrawal. However, the account will become part of the trusts. The surviving spouse will commence taking minimum distributions calculated over the life expectancy of the remaining spouse. Also, the surviving spouse cannot change the beneficiaries of the account after the surviving spouse dies.

Estate Tax Consequences of a Surviving Spouse Who Inherits a 401(k) or IRA

While 100 percent of the fair market value of the 401(k) or IRA, it will always be included in the deceased spouse’s estate for tax purposes. Since the spouses can leave their assets at death without any tax encumbrances due to the limited marital deductions, the remaining spouse won’t owe the estate taxes on the 401(k) or IRA. Instead, 100 percent of their market value in the 401(k) or IRA will be included in the estate if the surviving spouse dies. On the contrary, the 401(k) or IRA would fund the B trust.

Tax Consequences If You Are Not a Surviving Spouse

If you are not a spouse of the deceased who owned the 401(k) or IRA, the income tax encumbrances of inheriting the account will depend on what you do with the account.

Transfer the account into an inherited IRA — If you choose to transfer the account into the IRA, you will start taking the minimum distributions by December. The amount of money you receive will be calculated over your life expectancy. You might also choose to take additional amount as stated in the schedule. The amount is also distributed as taxable income.

Ultimately, it may be wise to seek the legal advice of a knowledgeable estate planning attorney or accountant in order to decide if a living trust is your best choice.