When an individual would like to save money for future expenses, he has a number of options. These options include retirement accounts offered through employers, annuities and individual savings accounts. The rules on the handling of an investment account once the owner is deceased vary by the type of account.
Qualified Retirement Accounts
A qualified retirement account, the type generally offered through employers, is an account that may be funded with pre-tax income. These accounts, which include traditional IRAs and 401(k)s, may be distributed in several different ways when an owner is deceased. If a retirement account goes to one beneficiary, that beneficiary can often roll the funds in the account into his personal IRA or 401(k), or may continue to receive distributions on a monthly basis. However, since no taxes were paid on the funds in the account, the beneficiary must pay taxes on any distributions.
An annuity incorporates the payment rules right into the plan. Upon the death of the owner of the annuity, the person listed as the annuitant begins to receive payouts from the account on a prearranged schedule that corresponds to the annuitant’s life expectancy. Since an annuity is funded with money that has been taxed, the annuitant does not pay taxes on funds that were contributed to the account, but does pay tax on earnings on those contributions. If the annuitant dies before the annuity pays out, the account beneficiary receives the remainder of the payments in accordance with annuity rules.
Though a Roth IRA is designed primarily for retirement and other future expenses, a Roth must be funded, like an annuity, with money that has been taxed. Due to this, the owner may take out any contributions from the account at any time without penalty or further taxation. When the owner of a Roth IRA dies, the beneficiary of the Roth account may receive distributions or take out any contributions to the account without taxation. Only earnings will be taxed.
Lump Sum Withdrawals
With an investment account of a deceased person other than an annuity, which always pays out on a prearranged schedule, the beneficiary has the right to take the funds out of the account in a lump sum and close the account. If the beneficiary chooses to do this, the total amount of the withdrawal in the case of a qualified retirement account, or the total amount of earnings in a Roth IRA, must be declared as income in the same year as the account is closed. This can create a substantially larger tax burden than taking money from the account in distributions.