Putting together your estate plan can be frustrating at times. On top of your regular assets, such as your house, car, bank and brokerage accounts, you need to know who will inherit your Solo 401k and any other retirement plan assets. It’s not enough to know who you want to inherit items. You need to make sure everything complies with federal law. That’s especially true when we’re talking about finances in general, and Solo 401k plans in particular.
What is a Solo 401k? If you’re confused about the plan and who can apply for it, here’s some help. As for inheriting Solo 401k plan assets, there are several questions that need to be answered. Who can inherit the Solo 401k plan assets? When can they draw money out? Let’s take a look at each of these.
Remember that a Solo 401k plan require an active business. It is different than an Individual Retirement Arrangement (IRA). Therefore, it is the assets inside the Solo 401k that are inherited, not the plan itself.
If your business terminates with your passing, your survivors will need to wind down the Solo 401k plan. A Solo 401k may not remain active if the business is not operational. If you and your spouse work in your business together, your spouse may generally continue with the same Solo 401k plan.
However, if your spouse is the primary beneficiary and does not have a business, the assets will need to be rolled into another retirement plan. Similarly, if your beneficiaries are your children, they cannot take over your Solo 401k plan. They would roll the Solo 401k assets into an Inherited IRA or other complaint structure.
Who Can Inherit Solo 401k Plan Assets?
According to the IRS, when it comes to married couples, your significant other immediately becomes the primary recipient. That’s an automatic trigger. This means once the plan owner passes away, unless there are orders stating otherwise, the account switches to their spouse’s control.
With a Solo 401k plan, if you and your spouse work together in your business, generally your spouse would become the new plan trustee and manage the assets. However, if your spouse does not have a business, or does not work in your business with you, they would often roll the plan assets into an Inherited IRA.
Because your spouse has a special role according to the IRS, (s)he may often also roll funds into a traditional IRA, a qualified employer plan, a tax-sheltered annuity plan or a deferred compensation plan of a state or local government.
However, if the custodian cuts the distribution check to you personally, you have to deposit it into another retirement account within 60 days. Otherwise, the IRS could treat it as a taxable distribution.
“If a surviving spouse receives a distribution from his or her deceased spouse’s IRA, it can be rolled over into an IRA of the surviving spouse within (a) 60-day time limit,” the Internal Revenue Service states on its website.
But what if you and your spouse agreed to set the money aside for your children? Is that possible? According to the IRS, yes, you can name your children as primary beneficiaries. The same applies if you’re unmarried and don’t have any children. In fact, the beneficiary for your Solo 401k can be anyone you choose.
“A beneficiary can be any person or entity the owner chooses to receive the benefits,” the IRS says on its website.
If your spouse is not the primary beneficiary of the retirement plan, they may need to sign a form waiving their beneficiary rights.
Remember, the Solo 401k is a business owner’s retirement plan. If your children are your designated beneficiaries, they can inherit the Solo 401k plan assets. However, the Solo 401k itself will probably wind down if the business owner is no longer alive. To do this, make sure you designate a contingent successor trustee to handle the day to day management and asset rollovers. Keep in mind that children or other beneficiaries have limited options for rolling over inherited assets. Generally, they can either take a complete (taxable) distribution from the plan or transfer the assets to another compliant IRA.
When Can Distributions Start?
Once the inheritance is processed, another question pops up. When can distributions start? This depends on the types of distribution. Some are taxable, some aren’t. If you are the spouse/primary beneficiary, a distribution or rollover into another retirement plan, such as your own Solo 401k, can happen right away. Remember that once the business owner passes away and the business is no longer operational, the Solo 401k for that business must be shut down.
If you are a spouse rolling funds to another Solo 401k plan, or if you are keeping the business and same Solo 401k active that you had with your spouse – the rules about distribution depend on how old the original account holder was. Under federal law, the account holder is required to start withdrawing money once they turn 70 ½. This is known as Required Minimum Distributions. Now if the original holder died before reaching that age, the clock switches over to their beneficiaries, who have until their own 70th birthday before they are required to withdraw.
On the other hand, if the original holder was older than 70 ½, that means they had already started taking distributions from the plan. You can’t stop that as a beneficiary, but the distribution amounts can look very different. The IRS will base the required distribution on the beneficiary’s age instead of the original holder’s age. That means beneficiaries can stretch out the distributions through tax-deferred growth. Always work with your CPA to ensure you are properly calculating and documenting distributions.
Now all of that depends on keeping the assets in a Solo 401k plan. If you rolled funds into another IRA, then the clock starts ticking. Distributions may need to begin at least on a yearly basis by December 31 of the same year.
As an example. Your father passed away in June 2019, and he named you as beneficiary of the Solo 401k assets. You’ll roll those assets into your own IRA account and that generally happens within a few weeks. You may then have to start taking at least a yearly distribution from the account by December 31, 2019 to avoid penalties. It’s also worth pointing out these penalties are not small. The IRS can levy fines of up to 50 percent of the total asset value. Always work with your CPA for an Inherited IRA to see if distributions are required in your situation.