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A guide to your inherited 401(k)

Learn how to handle and maximize a 401(k) you inherited from a loved one.

So you recently inherited a 401(k). What next?

Certain rules affect when and how you can access your recent inheritance. This guide will help you navigate those rules and help determine when you might want to take the cash or let it grow.

What happens when you inherit a 401(k)

If you’ve inherited a 401(k), it means the account holder listed you as a primary beneficiary or contingent beneficiary. A contingent beneficiary is eligible to inherit the 401(k) if the primary beneficiary — often a spouse — is unable to receive the benefit. This can happen if the primary beneficiary has also died or can’t be located.

As the beneficiary of a 401(k) from someone other than your spouse, you have limited time to use the funds in the account.

  • The five-year rule allows you to take distributions over five years, drawing down the entire balance by the end of the fifth year after the original account owner’s death.
  • The life-expectancy rule lets you take annual distributions over your life expectancy. This is determined using one of the life expectancy tables published by the IRS — the Uniform Lifetime Table, the Single Life Expectancy table or the Joint Life and Last Survivor Expectancy table.

If you inherited a 401(k) before 2020 and the owner died before their required beginning date — the date of the first required minimum distribution (RMD) — you’re generally able to choose between the five-year rule and the life-expectancy rule. Both are IRS rules governing how and when beneficiaries can take distributions from inherited retirement accounts.

If you’ve inherited the 401(k) on or after January 1, 2020, you have 10 years to withdraw the assets from the 401(k). The 2019 Secure Act eliminated the ability to stretch your taxable distributions and associated tax payments over your life expectancy.

Exceptions to the rules under the 2019 Secure Act

There are exceptions to these new rules, and in these cases, you can still generally stretch out your distributions over your lifetime. The following are four types of eligible designated beneficiaries that are excluded from these new rules:

  • Surviving spouse of the original account owner
  • Minor child of the original account owner*
  • Disabled/chronically ill individual
  • Individual not more than 10 years younger than the original account owner

*Minor children must take remaining distributions within 10 years of reaching the age of 18.

How to proceed after inheriting a 401(k)

Ultimately, your next steps after inheriting a 401(k) depend on factors that include:

  • Your relationship to the 401(k) owner. Your options change depending on whether you inherit your 401(k) from your spouse, parent or someone else.
  • The year in which the account holder died. If the owner died after December 31, 2019, the entire balance must be distributed within ten years. An exception applies for the four types of eligible designated beneficiaries.
  • Your age. If you’re more than 10 years younger than the 401(k) owner, you’re an eligible designated beneficiary and can generally still stretch out distributions over your lifetime. If you’re under 18 and the child of the 401(k) owner, you can take RMDs until you turn 18, at which point you must take remaining distributions within the next 10 years.
  • Your health. If you have a chronic illness or are disabled, you qualify as an eligible designated beneficiary and should be able to stretch out distributions over your lifetime.
  • 401(k) rules. Review the 401(k) plan documents or speak with the plan administrator to see if the inherited funds must be withdrawn immediately or can be withdrawn in smaller amounts over time.

Spousal vs. nonspousal inherited 401(k)s

You can inherit a 401(k) from your spouse or another person, though the distribution rules differ between these scenarios. If you inherit a spousal 401(k) or you qualify as an eligible designated beneficiary, the new rules in the Secure Act generally won’t apply, and you should still be able to stretch distributions over your lifetime.

If you inherit a 401(k) from anyone other than your spouse or are not considered an eligible designated beneficiary, you must withdraw the full 401(k) balance within 10 years of the account owner’s death.

You’ll find more flexibility around RMDs if you inherit a 401(k) from a spouse or are an eligible designated beneficiary.

Spousal 401(k)

Surviving spouses have the greatest flexibility when it comes to their options after inheriting a 401(k). Distribution options depend on your age and your spouse’s age at the time of their death. The 401(k) plan documents should establish the RMD rules.

Your spouse’s ageYour ageInherited 401(k) options
72 or older72 or older
  • Leave the funds in the inherited 401(k), if permitted, and take RMDs based on the plan’s RMD rules
  • Roll the funds into your own 401(k), if permitted, and calculate RMDs using the Uniform Lifetime Table.
  • Roll the funds into your own IRA and take RMDs based on the Uniform Lifetime Table
  • Roll the funds into an inherited IRA and take RMDs based on the Single Life Lifetime Table
  • Take a lump sum distribution
72 or older59 ½ or older but younger than 72
  • Leave the funds in the inherited 401(k), if permitted, and take RMDs based on the plan’s RMD rules
  • Roll the funds into your own 401(k), if permitted, and calculate RMDs using the Uniform Lifetime Table.
  • Roll the funds into your own IRA and delay distributions until you reach age 72
  • Roll the funds into an inherited IRA and calculate RMDs using the Single Life Expectancy Table**
  • Take a lump sum distribution
Younger than 7259 ½ or older but younger than 72
  • Leave the funds in the 401(k), if permitted, and take RMDs based on when your spouse would have reached RMD age
  • Roll the funds over to your own IRA and delay distributions until you reach 72. Roll the funds over to an inherited IRA and calculate RMDs using the Single Life Expectancy Table**
  • Roll the funds over to an inherited IRA and use the 10-year method
  • Take a lump sum distribution
Younger than 72Younger than 59 ½ years old
  • Leave the funds in the 401(k), if permitted, and take distributions whenever without incurring the 10% early withdrawal penalty
  • Roll the funds into your own IRA (early distributions are subject to a 10% penalty)
  • Roll the funds into an inherited IRA and take RMDs based on the Single Life Expectancy Table**

**Spouses more than 10 years younger and are the sole beneficiary use the Joint Life and Last Survivor Expectancy table

Nonspousal 401(k)

The following distribution rules apply to non-spouse beneficiaries who are considered eligible designated beneficiaries:

  • Minor child. Minors can take RMDs until they turn 18, at which point they flip over to the 10-year depletion rule.
  • Chronically ill or disabled. Beneficiaries can take distributions based on their own life expectancy and are not subject to the 10-year rule.
  • Individual not more than 10 years younger than the original account owner. Beneficiaries can take distributions based on their own life expectancy and are not subject to the 10-year rule.

If you inherit a nonspousal 401(k) and are not considered an eligible designated beneficiary, the Secure Act stipulates that you must empty the account within 10 years of the original owner’s death. You may be able to leave the funds in the inherited 401(k) plan or roll the funds into an inherited IRA and take distributions according to your own RMD requirements.

Tax considerations

The amount you’ll pay in taxes for an inherited 401(k) tax depends on your relationship to the original account owner and your age when you inherited the 401(k).

Table A: Taxes for a spousal 401(k)

Your ageTax treatment
72 and older
  • Taxed at ordinary income tax rates
  • No early withdrawal penalty
59 ½ to 72
  • Taxed at ordinary income tax rates
  • No early withdrawal penalty
Under 59 ½
  • Taxed at ordinary income tax rates
  • No early withdrawal penalty, unless the funds are rolled into your own IRA prior to taking distributions

Table B: Taxes for a nonspousal 401(k)

Your ageTax treatment
72 and older
  • Taxed as ordinary income
  • No early withdrawal penalty
59 ½ to 72
  • Taxed as ordinary income
  • No early withdrawal penalty
Under 59 ½
  • Taxed as ordinary income
  • No early withdrawal penalty

Options

You have several options for withdrawing money from your inherited 401(k).

OptionProCon
Lump-sum distribution
  • Simple
  • Offers large cash influx
  • Large tax bill due in a single year
  • Must manage a large sum of cash
  • Lose out on future growth if not reinvested
Rollover into your own 401(k) or IRA (spouses only)
  • Delays withdrawals and thus taxes until retirement
  • Maximizes tax-deferred growth
  • Can’t withdraw money before 59 ½ without 10% penalty
  • A 401(k) rollover might not be permissible under your plan or the original account owner’s plan
Withdraw all funds by 5 years after owner’s death (if owner died before 2020)
  • Spreads out tax liability
  • Take money when you need it
  • Offers more money per year than lifetime method or 10-year method
  • Lose out on some tax-deferred growth
  • Not available if original owner was taking RMDs before death
Withdraw all funds by 10 years after owner’s death (if owner died after 2020)
  • Spreads out tax liability
  • Offers more money per year than lifetime method
  • Lose out on some tax-deferred growth
Withdrawals spread over your lifetime, if qualifications are met and owner died in 2020 or later
  • Spreads out tax liability the most
  • Maximizes time for tax-deferred growth
  • Least amount of money available up front
  • Not available in all 401(k) plans

Note that most of the withdrawal rules here also apply if the beneficiary is a foreign citizen — for example, a spouse or a child with citizenship in a foreign country. But you can’t roll money from a U.S. retirement plan into another country’s retirement plan.

Should you take the money?

Taxes can be the most important factor when deciding what to do with an inherited retirement plan.

If you think your tax rate will increase within your 10-year period, you might consider taking the lump sum to minimize the taxes you’ll pay. On the other hand, if you expect your tax rate to decrease, holding off on any distributions until you’re in a lower tax bracket might be a better option.

If your tax rate will increaseIf your tax rate will stay flatIf your tax rate go down
  • Take a lump sum
  • Take a lump sum and reinvest the cash after-tax in a brokerage account
  • Convert the inherited 401(k) to an inherited Roth IRA
  • If the account is small consider letting it grow
  • Spread distributions over the 10-year period for larger 401(k)s
  • Wait until your tax rate decreases to begin distributions

Investing your inherited 401(k)

If you don’t need the money right away, consider reinvesting the funds from the inherited 401(k) for continued growth. Surviving spouses can roll the funds into their own IRA or an inherited IRA.

Non-spouse beneficiaries can roll over their inherited funds to an inherited IRA. If you have an existing 401(k), check with your plan administrator to see if you can roll your inherited funds into your existing 401(k).

Rolling your inherited funds into your own IRA or a new inherited IRA can typically be done by following these steps:

Step One: Choose the type of account you want

Surviving spouses can choose between an existing IRA and a new inherited IRA. If you roll the funds into a new inherited IRA, distributions won’t be subject to the 10% early withdrawal penalty, even if you’re under age 59 ½. Non-spouse beneficiaries typically can only roll the money into an inherited IRA.

Step Two: Decide where you want to open an inherited IRA

If you’re a surviving spouse and already have an IRA, you’ll know exactly where to send your inherited funds. If you’re opening a new inherited IRA, you’ll need to decide on a broker or bank. Compare brokers and banks by fees and commissions, reputation and investment options.

Step Three: Open your account and begin the rollover process

With your new account open, fill out any necessary paperwork to complete your rollover. Both the plan administrator from the inherited 401(k) plan and the bank or broker for your new account tell you what they need to start the process.

A direct rollover will move the funds straight from your inherited 401(k) into your new account. If the check is made payable to you, you might get hit with mandatory withholding taxes and an early withdrawal penalty.

Step Four: Choose your investments

Once the funds are transferred to your existing IRA or new inherited IRA, you can invest the money how you see fit.

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Bottom line

Inheriting a 401(k) can provide a significant boost to your financial security. But several factors affect what you can do with the account, when you can take the money and the tax liability. Before you take action, consult with your tax professional or someone experienced in transferring these accounts. You can also refer to our retirement guide for more guidance on retirement planning.

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