Generational Wealth: 2 Things You Should Know About Inheriting Someone’s 401(k)
Written by
Gina Hagler
Edited by
Nicholas Morine
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Inheriting a 401(k) can be a confusing process as there are a number of conditions that affect what you are able to do. Your options differ depending on whether you are the spouse beneficiary or not, how many required minimum distributions (RMDs) have been taken and at what age the owner passed away, as Fidelity outlined. An RMD is the amount of money you may have to withdraw from a 401(k) or individual retirement account (IRA) each year.
Here’s what you should know about inheriting a 401(k) and the options you’ll have depending on your relationship to the deceased.
On Spousal Beneficiaries
Spouse beneficiaries younger than 59½ have four primary options, per Edelman Financial Engines.
First, a spouse can take a lump-sum distribution, where they receive the entirety of the distribution funds at once. This results in regular income taxes being applied and they may be moved into a higher tax bracket.
Second, they can transfer ownership, placing the assets into their own 401(k) or IRA — this option carries a 10% early withdrawal penalty.
Third, a spouse can open an inherited IRA, wherein the funds are rolled over into a new account in their name, allowing them to take distributions without the aforementioned penalty (even if they’re younger than 59½).
Last, a spouse can also choose to do nothing and take regular distributions — taxes apply, though there is no 10% early withdrawal penalty. Spouse beneficiaries older than 59½ usually avoid the penalty regardless of which of the four options they go with. If the original account owner had been taking the yearly RMDs, the beneficiary can either continue doing so or delay them until they reach age 73. Those 73 or older generally have to take the RMDs regardless of which of the four options they select.
Non-spouse Beneficiaries
Non-spouse beneficiaries can also take a lump-sum distribution, according to Fidelity. When it comes to rolling over the funds in an inherited IRA, there are some distinctions.
Non-spouses cannot make contributions and the process to empty the account differs. Non-spouses might have to withdraw all funds within 10 years of the original owner’s date of passing if the inherited account was opened after January 1, 2020. Throughout those 10 years, non-spouses must also take as many RMDs as would have been taken per the remainder of the original owner’s life expectancy — or be penalized with 25% of the remaining balance.
This rule does not apply to beneficiaries who are minor children of the original owner or otherwise less than 10 years younger than them, or those who are disabled or diagnosed with a chronic illness.
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