Accessing Funds: Tax Implications of Death Benefits
Under IRS rules, distributions to beneficiaries are subject to income taxes. Note that there is no additional tax for early payment. If the beneficiary is the participant’s surviving spouse, the plan must withhold federal income tax of 20% of the taxable portion of any distribution that is eligible for rollover, unless the surviving spouse completes a “direct rollover.” If the beneficiary is not the spouse, the taxable portion is subject to 10% voluntary federal income tax withholding (unless the beneficiary elects not to have any tax withheld or makes a direct rollover to an inherited IRA). The plan must also comply with any mandatory state income tax withholding rules (which vary by state). Beneficiaries (including spouses) will receive credit for payment of withholding taxes when they file their annual tax returns for the year in which the distribution was made. Also, beneficiaries who want to elect additional withholding from the payment may complete IRS Form W-4P before receiving the distribution. Form W-4P must accompany the distribution paperwork.
Surviving spouses who receive a check payable to them can roll over the full distribution amount within 60 days of their receipt of the check. However, to roll over the entire amount of the payment, the surviving spouse should, but is not required to, find other money to replace the 20% that was withheld for the federal income tax. The surviving spouse receives credit for the taxes paid when he or she files his or her federal income tax return for that year. If the surviving spouse only rolls over the 80% that was received, he or she will still be taxed on the 20% that was withheld and not rolled over. This option is not available to non-spouse beneficiaries — they can only make a direct rollover.
Amounts rolled over will not be taxed until the beneficiary receives a payment from the IRA or other eligible account to which the distribution was rolled over.
Both a surviving spouse and other designated beneficiary may be able to use the special tax treatment for lump-sum distributions. The beneficiary should see his or her tax advisor for more information.Avoiding a Tax Penalty on Distributions
Timing of Distribution
The Program will mail a check (if applicable) to the beneficiary within two business days from when the death claim is processed.
Avoiding a Tax Penalty on Distributions
The surviving spouse can avoid paying current withholding taxes and penalties by requesting a direct rollover to:
- An individual retirement account (IRA), or
- An eligible employer-sponsored plan.
A non-spouse beneficiary can request a rollover only to an inherited IRA (an IRA opened exclusively for purposes of receiving the rollover from the retirement plan).
These are general tax guidelines. Beneficiaries should always be directed to seek tax advice from their legal or tax advisor.