My Father passed away. I understand that I am named the beneficiary on his work 401k, which is substantial. I have contacted his employer to get the money, but they have told me I can’t have it all, there will be a ‘with holding’. What are they talking about I would like the money to buy a cottage.
Pre-tax investments have a down side. At some point taxes have to be paid. When money was put into the 401k your Father was able to reduce his yearly income by the amount of funds placed into the 401k. The reasoning being that he would take the money out when he was retired, and earning less income, and would pay the tax on the amount he took each year then. An example: if you Father earned $50,000 a year, but he put $5,000 into his 401k, he only paid Federal and State income tax on $45,000, not $50,000. When he retired at age 65 or so, he would take yearly withdrawals from his 401k and add it to his income. So if he earned $25,000 from social security, and took $5,000 from his 401k, then he paid income tax on $30,000. The theory being he would be in a lower tax bracket when he retired and he would then be able to keep more of his money.
So what happens when a person passes away prior to taking the money out of the 401k? Someone has to paid taxes on it, and that person is the one who receives the money. So if your Father had a $200,000, 401k, and you decided to take it all at once, you would add $200,000 to your yearly income, jumping you way up in tax brackets. Roughly you would loose about 1/3 of the money in taxes. That’s the with holding. The employer is required to pay to the IRS a portion of the money in advance so that when your taxes are due in April of next year, there will be enough money to pay the taxes.
If you want the money, your best option is to take it over time, but you can only do that if you are over the age of 59 ½. What you would do is take the 401k, and roll it over into what is called ‘an inherited IRA’. It would be in your name, and once it is, then you may remove the money, subject to the same rules that everyone else has for withdrawal of pre-tax money.
With large pre-tax investments, the best way of looking at it, is as an additional retirement benefit for you, and hang onto the money until you are older. If you do not wish to wait. Then you will loose a portion of the funds in Federal and State taxes. This is one of those gifts that just are not the same value as what it looks like.
As always this is a general answer, to a general question. You should always consult your attorney about the specific issues that surround your specific needs.
If you have a question for Attorney Kukuvka, please forward it to: Cynthia M. Kukuvka, Attorney at Law, 330 E. Main St., Palmyra, NY 14522 or cklaw@verizon.net