IRS Rules Governing Rollover of Inherited 401(k) Funds Into Inherited IRA

by Fraser Sherman
If you inherited a 401(k) from your spouse, you can make a rollover.

For many people, the rules for rolling over an inherited 401(k) are simple: Don't. It's one thing to transfer assets from a 401(k) you set up, but the law treats inherited accounts differently. According to the Internal Revenue Service, the only time you can roll an inherited 401(k) over to an inherited IRA is when you received both accounts from your spouse.

Spouses and Others

Spouses who inherit retirement accounts don't face the same rules as everyone else. For example, if you inherit an individual retirement account from a parent or sibling, you can't add more money to the account, and that includes rollovers. You also can't roll an inherited 401(k) over to another account in that situation. However, a spouse gets to treat an inherited IRA as if she set up the account, so she can roll money into it. She can also roll money out of an inherited 401(k).

Claiming the Account

Even as a spouse, you only get to make rollovers if you're the sole beneficiary. If your spouse named you and your child as co-beneficiaries, you don't get the special spousal options. You must show the IRS you want to treat the account as your own, not as an inherited account. You don't have to sign a statement of intent -- just making the rollover from the 401(k) proves you're claiming your spousal privileges.

Methods

When you make a rollover, you can have the account managers do it for you or withdraw the money and transfer it yourself. Both options are tax-free. However, if you handle the transfer personally, you have only 60 days to do it or you'll owe taxes as if you'd withdrawn the money. Some beneficiaries like the idea of using the cash as a 60-day loan, but that's risky. Make the deposit even one day late and the tax kicks in.

Alternatives

Rolling over an inherited 401(k) isn't always such a great idea. Once you deposit the money in your inherited IRA, you have to treat it like your own retirement account, so there's no withdrawal until you turn age 59 1/2. Any earlier and you pay a 10 percent penalty on withdrawals, along with regular income taxes. If you keep the cash in your inherited 401(k), there's no penalty if you start withdrawing money, although it's still taxable income.

About the Author

A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.

Photo Credits

  • Stockbyte/Stockbyte/Getty Images