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Death Benefit, how is it taxed?


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I have read:

(1) that a younger beneficiary of a deceased plan participant is entitled to take a lump sum distribution and not be subject to the 10% premature distribution tax because the deceased participant was older than 59-1/2.  

(2) But then I also read that   "the lump sum you receive will be subject to local, state and federal income tax. However, you will not have to pay the 10% early withdrawal tax even if you and/or the deceased person are under 59 ½"  That seems fair to me, but then I don't decide what is fair.

Is #2 correct?
 

And on the side, the spouse of the beneficiary has no bearing at all on any tax matters.

 

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5 hours ago, C. B. Zeller said:

Distributions paid to a beneficiary of a deceased participant are exempt from the 10% early withdrawal tax. IRC 72(t)(2)(A)(ii)

And Basically, it has to be on account of the death. Meaning if the money comes to the beneficiary directly from the decedent's qualified employer plan account or from the decedent's IRA, fine, no 10% tax at any age. But if the beneficiary rolls it over, even without commingling with any other assets, and then later takes a distribution from the rollover account, it may, in fact, still be the money left to the beneficiary by the decedent, plus a little earnings, but it does not enjoy the death benefit exception from the 10% tax.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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On 6/21/2022 at 2:12 PM, Luke Bailey said:

And Basically, it has to be on account of the death. Meaning if the money comes to the beneficiary directly from the decedent's qualified employer plan account or from the decedent's IRA, fine, no 10% tax at any age. But if the beneficiary rolls it over, even without commingling with any other assets, and then later takes a distribution from the rollover account, it may, in fact, still be the money left to the beneficiary by the decedent, plus a little earnings, but it does not enjoy the death benefit exception from the 10% tax.

I believe you can roll to an inherited IRA and retain the death benefit exemption from the 10% tax.

But if the spouse treats it as his or her own it loses the death benefit status.

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On 6/21/2022 at 5:12 PM, Luke Bailey said:

And Basically, it has to be on account of the death. Meaning if the money comes to the beneficiary directly from the decedent's qualified employer plan account or from the decedent's IRA, fine, no 10% tax at any age. But if the beneficiary rolls it over, even without commingling with any other assets, and then later takes a distribution from the rollover account, it may, in fact, still be the money left to the beneficiary by the decedent, plus a little earnings, but it does not enjoy the death benefit exception from the 10% tax.

Hi Luke,
That is true, if the beneficiary is the surviving spouse who rolls the amount to his/her own IRA/retirement account. No other beneficiary may rollover an inherited IRA or other inherited retirement account- except for a direct rollover from an employer plan- and even then the rollover must be a direct rollover to a beneficiary IRA, which retains the exception to the 10% penalty.

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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On 6/25/2022 at 3:01 PM, Appleby said:

the rollover must be a direct rollover to a beneficiary IRA, which retains the exception to the 10% penalty.

Good to highlight that point, Appleby.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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