Cashing out an inherited 401K

[artjcatl]

I'm inheriting a 401K account from a deceased family member. I'm the beneficiary on the account and I'm younger than the 59 years old required for penalty free withdrawals.

The account has about $100K in it and I'm planning on cashing it out. 

I'm aware that I can roll it over into an IRA to avoid the taxes and penalties. However I'm planning on cashing it out. 

I would like to get a better understanding of the tax implications (federal + state (Georgia)) and penalties associated with cashing out a 401K account with this amount of money.

Also are there any inheritance taxes that will be associated with inheriting this account?

If I decide to gift this money to some family members are there any additional tax implications for this?

Thanks

[Bsch4477]

Even if you're under age 59 ½, the usual age at which penalty-free withdrawals are allowed, you can take money out of an inherited account without an early-withdrawal penalty. You will, however, have to pay income tax on the amount that you withdraw. 

After you withdraw the money you can gift  up to $16,000 to each individual without having to file form 709. 

No inheritance tax liability for you. Any inheritance tax would be paid by the state. 

Understand that withdrawing that amount of money might put you in a higher tax bracket that could be avoided by periodic annual withdrawals.

[artjcatl]

Thank you so much for the response. I didnt even know about Form 709 will research that.

I'm also under 59 years old so good to hear I wont have to pay the early withdrawal penalty fee.

[DoninGA]

The state of Georgia does not have an inheritance tax.  The adjusted gross income from the federal tax return is the income basis on a Georgia state tax return.

[Opus 17]

You can rollover an inherited IRA into a different account but it will always be considered an inherited IRA and will always follow the rules for an inherited IRA.  You must cash out the account and close it within 10 years, which means withdrawing the money and paying the tax.  You can't roll the money over into a personal (non-inherited) IRA to save for your own retirement.

You can withdraw the money, pay the tax, and then use that money to fund a new IRA.  Your deductible IRA contributions are limited per the normal rules to $6000 if you are under age 50, and they may be further limited by your participation in a workplace plan.  You can't directly move the inherited IRA into a personal IRA.

Withdrawals from an inherited IRA are subject to regular income tax but are exempt from the 10% penalty for early withdrawals even if you are under age 59-1/2.  However, a large lump sum of income may place you in a higher tax bracket.  You might also be required to pay estimated income tax to the IRS and your state when you make the withdrawal, to avoid an under-payment penalty at tax time.  

Gifts of more than $16,000 per person must be reported on form 709, but there is no tax actually owed unless your lifetime gifts are more than $11 million.

There is no federal inheritance tax.  A quick internet search indicates Georgia does not have an inheritance tax.  

If you are not an "eligible" beneficiary, then you follow the 10 year rule.

An eligible designated beneficiary is the owner's surviving spouse, the owner's minor child, a disabled individual, a chronically ill individual, or any other individual who is not more than 10 years younger than the IRA owner.

The 10 year rule means you must withdraw all the money, pay the taxes, and close the account by December 31 of the year containing the tenth anniversary of the account owner's death.  

The IRS is considering new rules that if the original owner was over age 72-1/2 (meaning they were required to take a required minimum distribution based on life expectancy) when they died, then the beneficiary must also take an RMD each year the account is open, unless they take more than the minimum required or cash out and close the account.  If you don't cash out the account, you should check here at the end of November to see if an RMD will be required of you for 2022. 

[artjcatl]

@Opus 17 , @DoninGA , @Bsch4477 
I found out that I'll actually be inheriting 2 separate 401K plans as the beneficiary. I'm a non-spousal beneficiary.

The 1st 401K plan is a traditional pretax 401K with about $30K.

The 2nd plan contains both pretax 401K & Roth 401K funds. The pretax funds are $5K and about $100K in Roth 401K funds.

What would the taxes due be for federal and state (GA) for cashing out these two 401K plans?

I believe there is no 10% penalty for both 401K plans because I'm inheriting the funds due to original owner dying correct?

Will the Roth 401K portion of the funds be taxed and counted as income or this only applies to the pretax portion of the 401K funds?

Thanks

[Opus 17]

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@artjcatl wrote:

@Opus 17 , @DoninGA , @Bsch4477 
I found out that I'll actually be inheriting 2 separate 401K plans as the beneficiary. I'm a non-spousal beneficiary.

The 1st 401K plan is a traditional pretax 401K with about $30K.

The 2nd plan contains both pretax 401K & Roth 401K funds. The pretax funds are $5K and about $100K in Roth 401K funds.

What would the taxes due be for federal and state (GA) for cashing out these two 401K plans?

I believe there is no 10% penalty for both 401K plans because I'm inheriting the funds due to original owner dying correct?

Will the Roth 401K portion of the funds be taxed and counted as income or this only applies to the pretax portion of the 401K funds?

Thanks

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You can't keep the 401(k) as a 401(k), you must either cash it out or roll it over to an inherited IRA.

If you cash out completely, you will pay regular income tax on the pre-tax portion.  The designated Roth portion is not taxable. You don't pay the 10% penalty even though you are under age 59-1/2.

If you rollover the money to an IRA, the pre-tax portion will go into a traditional IRA and the designated Roth portion must go into a separate Roth IRA (they can be with the same bank, of course).  Then you have 10 years to withdraw the money.  Spreading the money out may reduce the tax you eventually pay, depending on your other income. 

To estimate your federal income tax, you need to know about other income, dependents, and credits.  You can try the Turbotax TaxCaster.

TaxCaster tax calculator

Georgia's tax rate is 5.75%.

If you have a large lump sum of income, you are supposed to make estimated tax payments.  If you don't, you could owe an under-payment penalty even if you pay in full when you file your return.  You should make estimated tax payments to the IRS and Georgia by January 15, for a lump sum income received between September and December.  If you pay too much in your estimate, it will come back to you in your tax refund when you file your tax return.  Since you only have $35K of taxable income, a 15% payment to the IRS and a 5.75% payment to Georgia will probably work.  Or you can ask the 401k trustee to withhold the taxes for you.

Remember that any taxes withheld are only an estimate.  You report the distributions on your income tax return where the actual tax due is calculated based on all your income, deductions and credits for the year. 

[artjcatl]

@Opus 17  thank you so much for the detailed response. You answered all the questions I had.