Feb 1, 2006 12:00 PM

By Christopher R. Hoyt, professor, University of Missouri (Kansas City) School of Law, Kansas City,

A complete liquidation of a person's retirement account can trigger a huge income tax liability, significantly diminishing assets available for investment. For example, a person who withdraws $100,000 from a 401(k) plan will have to report $100,000 of taxable income, producing combined federal and state income taxes of roughly $40,000 and leaving only $60,000 to invest. Had the $100,000 stayed in the plan, the $40,000 would have generated significant investment income, but the taxation of the distribution permanently deprived the individual of that revenue. Over 16 million people have received lump sum distributions and less than half rolled over the entire distribution to defer taxation.¹

There are many opportunities for employees to defer paying taxes on lump sum distributions from their own account² — the most important of which is the rollover. But opportunities are extremely restricted for beneficiaries after an employee's death. Distributions from an inherited retirement account are taxable as income in respect of a decedent (IRD).³ Only a surviving spouse can rollover a distribution from an inherited retirement account⁴ — nobody else can.⁵ The laws permit payments from a decedent's retirement account to be made over a beneficiary's remaining life expectancy;⁶ but as a practical matter, very few companies make that opportunity available to beneficiaries. Businesses do not want the burden of keeping track of the whereabouts of every beneficiary of every employee who ever worked for them. Consequently, many plan documents require a deceased employee's retirement account to be liquidated within one year of death. How can the beneficiaries of unmarried employees at such companies defer paying income taxes on lump sum distributions?

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Topics of Interest

Estate Tax	Donor Advised Funds
GSTs	Family Offices
Private Foundations	Life Insurance
2010 Tax Act News	Industry Trends Surveys

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2011 Trust Glossary

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50 years ago, in May 1962, we featured articles such as: "Future of Canadian Trusteeship" by Arthur H. Mingay", "Training Trust Employees" by Ian M. Marr, "What is a Trust Officer?" by Eric J. Brown, and "Selling Services" by Donald I. Webb.

Conrad Teitell's Guide to Tax Benefits For Charitable Gifts

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