Inherited 401(k) Options and Rules You Must Follow

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.

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after-tax money for contributions, so you pay the income taxes immediately, but your money will not be taxed when it is withdrawn.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:

1. 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.
2. 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.
3. 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 disbursement.
4. You can disclaim the account and pass it to an alternate beneficiary.

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 disbursement 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.

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.