Inheriting a 401(k) following the death of the account owner isn’t always as straightforward as inheriting other types of assets. The IRS has certain rules that 401(k) beneficiaries must follow to determine when and how much tax they’ll pay after inheriting someone’s retirement account. If you’re currently the beneficiary of a 401(k) or you’ve recently inherited one, here are the most important things you need to know. Consider working with a financial advisor as you make decisions about handling retirement money, especially one who can answer your difficult inheritance questions.

What Is an Inherited 401(k)?

An inherited 401(k) is simply a 401(k) that’s been passed on to a beneficiary upon the death of the original owner. If the original 401(k) owner is married, the inheritor is usually the surviving spouse. The exception to the rule is if the spouse signs a waiver allowing them to name someone else as their plan beneficiary.

If a spouse waives their right to inherit a 401(k) or the account owner is unmarried, the account can be left to whomever the account owner chooses. That includes children, siblings or other relatives, as well as a trust or charity.

The tax treatment of withdrawals that are taken from an inherited 401(k) is based on three key factors:

• Your relationship with the account owner
• Your age when you inherit the 401(k)
• The account owner’s age at death

Inheriting a 401(k) as a Spousal Beneficiary

If you inherit a 401(k) from your spouse, what you decide to do with it and the subsequent tax impacts may depend largely on your age. If you’re under age 59 ½, you can do one of three things:

1. Leave the Money in the Plan and Take Distributions

The 401(k) plan may allow surviving spouses to leave inherited 401(k) funds in the plan. If you go this route, you can take withdrawals from the account without triggering the 10% early withdrawal penalty. You’d still pay regular income tax on any distributions of tax-deferred funds.

If your spouse was age 73 or older when they died, you would have to take required minimum distributions (RMDs) from the account. Again, there would be no early withdrawal penalty but you would pay income tax on the withdrawals. If your spouse was younger than 73 when they passed away, you could wait until you reach RMD age yourself to begin taking withdrawals.

2. Transfer the Funds to an Inherited IRA

An inherited IRA is an individual retirement account that’s designed to hold inherited funds from an inherited retirement plan, including 401(k)s. You can make withdrawals without triggering an early withdrawal penalty. This kind of account would require you to take minimum distributions but the amount would be based on your own life expectancy, not the amount your spouse would have been required to take.

3. Roll the Money into Your Own IRA or 401(k)

As a spousal beneficiary, you have the unique ability to roll over the inherited 401(k) into your own IRA or another eligible retirement account. This option treats the funds as if they were originally yours, offering the benefit of consolidating your retirement savings into one account. By rolling over the funds, you can continue to grow the balance tax-deferred, giving you control over investment choices and distributions.

Another advantage of rolling the 401(k) into your own account is that RMDs are delayed until you turn 73, aligning with the standard rules for traditional retirement accounts. This delay can be especially useful if you’re younger than the RMD age or do not need the funds immediately. You can also contribute to the account if it’s a traditional IRA or 401(k), further increasing its value over time.

However, it’s worth noting that once the funds are rolled over, they are subject to standard IRA withdrawal rules, including penalties for early withdrawals before age 59 ½, unless exceptions apply. For younger spouses, this option might be less flexible if immediate access to funds is needed.

4. Withdraw the Entire Balance

You may choose to withdraw the entire 401(k) balance as a lump sum. This option can provide immediate access to funds but may result in a significant tax liability. RMD rules don’t apply since the entire account is liquidated.

Inheriting a 401(k) as a Non-Spouse

The rules governing how non-spouses inherit 401(k)s changed at the end of 2019. That’s when the SECURE Act came into effect. The law, which took effect in 2020, mandates that most non-spouse beneficiaries of 401(k)s, IRAs and other defined contribution plans have to withdraw all inherited funds within 10 years of the original owner’s death.

Known as the 10-year rule, this provision replaced the “stretch IRA,” which allowed non-spouse beneficiaries to take distributions from the account based on their life expectancy.

Understanding these options can help you navigate the financial and tax implications of inheriting a 401(k) from a non-spouse.

1. Transfer to an Inherited IRA

Non-spouse beneficiaries can transfer the 401(k) balance to an inherited IRA, also known as a beneficiary IRA. This allows you to stretch distributions over a specific timeline, depending on whether the original account holder passed before or after their required beginning date (RBD) for RMDs. Under the SECURE Act, most beneficiaries must fully withdraw the account balance within 10 years of the account holder’s death, unless they qualify as an eligible designated beneficiary (e.g., a minor child or someone chronically ill).

2. Keep the Account with the Plan Provider

In some cases, plan rules may allow you to leave the funds in the 401(k) under the original account, although this option is less common. RMDs will apply based on the 10-year rule or a specific schedule depending on your beneficiary status.

3. Take a Lump-Sum Distribution

Like spousal beneficiaries, non-spouse beneficiaries can also choose to take the entire balance as a lump sum. While this option provides immediate access to the funds, it comes with significant tax consequences. The full withdrawal amount is subject to ordinary income tax, which could push you into a higher tax bracket for the year. Careful consideration of the tax implications is crucial before choosing this route.

What to Do If You Inherit a 401(k)

Inheriting a 401(k) could raise some tricky tax questions if you’re concerned with minimizing your tax liability. Talking to a tax professional and an estate planning specialist can help you decide which course makes the most sense to reduce taxes while planning ahead for the long term.

For instance, if you’re rolling an inherited 401(k) to an inherited IRA or to your own IRA, you’d need to name beneficiaries for your account. You may want to ask your estate planner what the tax implications are for passing an inherited 401(k) on to your children or other family members.

Bottom Line

The most important thing to keep in mind when inheriting a 401(k) or any other type of retirement plan is that you can’t simply ignore it. While it may be difficult to think about money when a loved one has passed away, you’ll eventually need to decide what to do with it. Ideally, you’ve talked the details over with the account owner well beforehand so that when the time comes, you’re prepared to manage your newly inherited assets.

Tips for Managing an Inherited 401(k)

• If you need help managing a 401(k) that you’ve inherited and navigating the withdrawal rules, consider working with a financial advisor with retirement planning or estate planning expertise. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Make sure you’re thinking about your asset allocation when managing your 401(k). This is your mix of stocks, bonds and cash equivalents. Your retirement asset allocation is typically based on your risk tolerance, time horizon and income needs.

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