Ask the Expert: Tax breaks for heirs

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To preserve tax breaks for your heirs, name

To preserve tax breaks for your heirs, name contingent beneficiaries on your retirement accounts. Photo Credit: iStock

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Lynn Brenner Lynn Brenner

Brenner answers questions about all aspects of family finance.

I'm 76 years old and my husband is 78. I have a 457 deferred compensation plan. I was advised that the Internal Revenue Service would tax my account at 50 percent if some beneficiaries inherited it. I know my husband can roll the 457 into an IRA, but I was told that if my husband and I were to die in a common accident, other beneficiaries would have to pay a 50 percent penalty because this is a 457 plan.

That's not so. You've been misinformed, or misunderstood what you were told.

Under a previous law, only a surviving spouse could postpone taxes on an inherited workplace retirement account like a 401(k) or 457 by rolling it into an IRA. But since Jan. 1, 2007, this option has been available to any named beneficiary.

It's still true that only a surviving spouse can roll an inherited account into an IRA in his or her own name, thus postponing taxable withdrawals until age 701/2. But any beneficiary can move your 457 account into an inherited IRA, paying taxes only on minimum annual distributions that are based on his or her life expectancy. If your beneficiary is your 40-year-old niece, for example, and your account is worth $200,000, her first annual required distribution would be $4,587. The $195,413 balance would remain tax-deferred.

To protect your other heirs from being hit with a big tax bill if you and your husband die in a common accident, name them as the contingent beneficiaries on your 457 account. Alternatively, you can roll that account into an IRA of your own, with your husband as its primary beneficiary and other heirs as contingent beneficiaries.

The bottom line To preserve tax breaks for your heirs, name contingent beneficiaries on your retirement accounts.

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