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Your 401(k) and your heirs
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August 11, 2000: 9:56 a.m. ET
Learn how to leave your company plan to your heirs with less tax bite
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NEW YORK (CNNfn) - If you want to leave your 401(k) to a loved one, you may be worried about slapping your heir with a big tax liability. You'll need to keep in mind IRS rules as well as the regulations of your retirement plan.
In response to a reader's question, Heather Locus, a certified financial planner from Schaumburg, Ill, and a member of the Financial Planning Association, explains the basics on distributions for beneficiaries.
Ask the experts a question
I am well below retirement age. If I were to die tomorrow, I would want my heirs to inherit my 401(k) money in the most tax efficient way possible.
My plan says if I have more than one beneficiary they must take the money out immediately, while if I have a sole beneficiary they have five years to take the money out of the plan.
Can my beneficiary take a yearly distribution over the five years and therefore save on taxes, or are they locked into a lump sum distribution?
This is a very good question and an often overlooked planning obstacle.
With the large amount of money in retirement plans and the large taxes owed when cash distributions are received, it is well worth the time to research the guidelines governing these plans.
There are two sets of rules for retirement plans: 1) the IRS's Internal Revenue Code, and 2) the specific plan's document governing the 401(k), IRA, profit-sharing plan, 403(b) or other retirement plan.
The IRS' rules on distributions for beneficiaries if the owner died before reaching age 70-1/2 are:
1. No Named Beneficiary: the entire balance must be withdrawn by Dec. 31 of the fifth year after death.
2. Named Beneficiary is non-spouse: Can elect options for no named beneficiary; Or money may be distributed over the beneficiary's life expectancy if begun by Dec. 31 of the first year after death.
3. Named Beneficiary is spouse: Can elect options for no named beneficiary or non-spouse beneficiary; Or assets can stay in decedent's IRA until the year when decedent would have been 70-1/2. Spouses may also roll over assets to their own IRAs and defer distributions until age 70-1/2 (this is almost always the preferred choice).
While a plan cannot be more flexible, it may be more restrictive than the IRS allows.
It is not uncommon for plans to require distributions for non-spouse beneficiaries to be taken either immediately or over a maximum of five years, as many do not want the administrative hassles of paying a young beneficiary for 60 or more years.
Unfortunately, assets in a 401(k) are going to be restricted to the payout options for that specific plan and there is nothing you can do except talk to your company about updating its plan document.
Once you leave the company, you will probably want to rollover the 401(k) to an IRA with a custodian that allows the maximum flexibility the IRS offers. Be sure to read the custodian's IRA document, as not all custodians allow the maximum flexibility for non-spouse beneficiaries.
It would be uncommon for your plan to allow one beneficiary to take distributions over five years but require multiple beneficiaries to take the distribution immediately, so I would verify that you understood it correctly.
But again, they can write the plan as restrictive as they want to so your company may just not want the administrative work of paying multiple beneficiaries for multiple years.
For more information on the IRS' rules, see their Publication 590, which can be downloaded from their Web site. 
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