When a 401(k) owner dies, one 401(k) beneficiary or more will inherit the account. The assets in an inherited 401(k) can be kept in the plan, rolled over to another qualified employee plan or IRA or distributed as a lump sum. If distributions were taxable to the deceased 401(k) owner, they will also be taxable to the beneficiary. Some states also impose a 401(k) inheritance tax. The inheritance is not subject to the IRS 10 percent early withdrawal tax penalty. The 401(k) distribution rules for an inherited 401(k) depend on your relationship to the deceased and your age.
IRA Rollover Options
You can choose between two types of IRAs to accept a rollover from an inherited 401(k):
- Inherited IRA: This is an IRA set up under the deceased’s name, but for your benefit. With an inherited IRA, you may be able to stretch out the required minimum distributions (RMDs), thereby reducing the tax impact in any given year. This option is available to spouse and nonspouse beneficiaries.
- Your own IRA: You can merge the assets of the inherited 401(k) into your own IRA and observe your IRA’s normal RMD rules. This option is available only to spouses.
Distributions from a traditional 401(k) or traditional IRA are taxed as ordinary income at your marginal tax rate. Distributions from a Roth 401(k) or Roth IRA are tax-free as long as you follow the rules.
401(k) Benificiary – Spouses
The law requires a surviving spouse (which includes same-sex spouses) to be the sole beneficiary of a 401(k) unless the surviving spouse legally renounced the right, in writing. This is true even if your deceased spouse named different or no beneficiaries. As the surviving spouse, the rules requiring you to take RMDs depend on your age and the age of your spouse at the time of death:
- Both spouses over age 70 ½: Your spouse was subject to RMD rules at time of death, and you must, at minimum, observe those rules. You can do so by leaving the money in the 401(k) or by rolling it over to an inherited IRA or your own IRA. If you rollover to an IRA, you take RMDs based on your life expectancy.
- You are between ages 59 ½ and 70 ½: You can leave the assets in the 401(k) and take RMDs on the same schedule that applied to your deceased spouse. Alternatively, you can rollover the assets to an IRA (inherited or your own) and take RMDs based on your own life expectancy.
- You are under age 59 1/2: The rules are the same as if you had already reached age 59 ½, with one exception: If you rollover the 401(k) assets to your own IRA, any distributions you take before age 59 ½ will be subject to the 10 percent early withdrawal penalty unless you qualify for an exception.
Inheritance Rules for Nonspouses
If you are not the deceased’s surviving spouse, you can inherit a 401(k) as long as there is no spousal beneficiary. You might be a named beneficiary, or you might receive the inheritance as part of a probate court proceeding. If you inherit a 401(k) as a nonspouse, you can leave the money in the 401(k) or roll it over to an inherited IRA. You have these choices for taking RMDs:
- Deceased was over age 70 ½: You can take RMDs over the course of your own life expectancy or that of the deceased at time of death, whichever is longer.
- Deceased had not reached age 70 ½: You must distribute all the assets within five years of the last day in the year following the deceased’s death. However, the plan may give you the option to stretch RMDs over your lifetime based on your life expectancy.