When a loved one passes away, a 401(k) retirement account might be bequeathed to a spouse, family member, or friend. If you inherit such an account, here are your options and the rules you must follow.
Key Takeways
- All 401(k) accounts offer tax-deferred retirement savings.
- If you are married, you automatically inherit your spouse's 401(k) unless the will stipulates otherwise.
- Spouses have more options than other heirs.
What Is a 401(k)?
A 401(k) is an employer-sponsored retirement plan, typically funded through payroll deductions. Many employers match all or part of what their employees contribute as part of their benefits package.
Traditional 401(k)s are funded using pretax dollars, reducing your taxable income by the amount of your contribution. The taxes won't be due until you withdraw money from the account.Roth 401(k)s use after-tax money for contributions, so you pay the income taxes immediately, but your money will not be taxed when it is withdrawn.
Withdrawals can be made without penalty from your 401(k) when you have reached the age of 59½, and you must start taking required minimum distributions (RMDs) at the age of 73. After you die, any unused funds will pass to those you name as beneficiaries. If you do not name a beneficiary or the account's beneficiary is deceased, the account will become part of your estate.
Inheriting a 401(K) From Your Spouse
If you are the beneficiary of a 401(k) account, your options are dependent on your connection to the original owner. If you inherited the account from your spouse, you have more options than non-spousal beneficiaries. If you're a spouse:
- You can designate yourself as the owner and place the account in your name. You'll have to take the required minimum distributions (RMDs) based on your life expectancy, but you can also continue contributing to the account.
- You can transfer the money into an inherited IRA. Inherited IRAs can take the form of any IRA, including a Roth, traditional, SIMPLE, or SEP IRA.
- You can treat yourself as the beneficiary and withdraw the funds, accepting any taxes due at the time. If you're over 59½, you won't have to pay early withdrawal penalties. You will owe income tax on the disbursem*nt.
- You can disclaim the account and pass it to an alternate beneficiary.
Important
If your partner dies and you are not legally married, you are not entitled to that person's 401(k). Domestic partnerships require a beneficiary designation to inherit the account, even if you've been together for many years.
Options as a Non-Spousal Beneficiary
You may inherit a 401(k) account from someone you're not married to—like a parent, legal guardian, or friend. You are not allowed to roll the 401(k) over into your accounts. Instead, you have only two options: disclaim the account or empty the account by the end of the 10th year after the year of the account owner's death.
You must start taking RMDs from the inherited IRA by Dec. 31 of the year following the original owner's death. As a result of the recently adopted SECURE Act, you have 10 years after the original account holder's death to complete the RMDs.If you miss the deadline to begin the RMDs, your disbursem*nt amount will be calculated on the original account holder's life expectancy rather than your own.
If a beneficiary is disabled, chronically ill, the minor child of the account owner, or no more than 10 years younger than the original account holder, the beneficiary may stretch the distributions over their lifetime.
Can I Commingle Inherited 401(k)s With Current Accounts?
If you are the surviving spouse of the original 401(k) holder, you may roll their accounts into your own. You are not allowed to do this if you are not a spouse. Instead, you can take withdrawals from the account over 10 years.
What Are the Penalties for Withdrawing Money Before Age 59½?
Spouses can opt to transfer the 401(k)funds into aninherited IRA and make withdrawals without triggering an early withdrawal penalty from an inherited IRA. However, spouses will still have to pay income taxes on the money they withdraw. As part of the SECURE Act, non-spouse beneficiaries of 401(k)s can withdraw from the account at any time without penalty as long as the balance of the account is depleted by the end of the 10th year following the account owner’s death.This is called the 10-year rule.
Do I Have to Take RMDs if the Original Account Holder Was Younger Than 72?
If your spouse was too young to begin taking RMDs when they passed away, you don't have to start taking RMDs until the year that person would have been 73. For example, if Joe died at 63 in 2022, this widow wouldn't have to take the first RMD until 2032.
The Bottom Line
The rules and regulations surrounding inherited 401(k)s can be confusing. An experienced tax consultant or estate planner will be a tremendous asset as you determine your course of action. For spousal inherited 401(k)s, there are several options to choose from, but non-spousal beneficiaries must make decisions quickly to satisfy the law.
Correction—May 12, 2023: A previous version of this article incorrectly stated that non-spouse beneficiaries are subject to a 10% early withdrawal penalty fee if younger than age 59½.
