Retirement accounts are among the most common types of investment plans in the United States. There are more than 625,000 401k investment plans in the U.S., with more than 60 million active participants and millions of former employees and retired participants. It is no wonder that 401k investments are often part of an inheritance.
What is a 401k?
A 401k is a personal retirement savings plan that allows a person to save money through their employer. An employee signs up with their employer to have a specific amount of money put into the plan with every paycheck. The employer may match part or all of an employee’s contribution. The employee may be allowed to choose the investment options such as mutual funds. Participants generally may withdraw funds tax-free after the age of 59 1 ⁄ 2 if they meet the criteria and are required to start making required minimum distributions (RMDs) after age 72.
What are the Rules for Inherited 401k?
The rules for inherited 401k funds are included in the Secure Act. The rules are different depending on whether you are a spouse or non-spouse. There are also different rules if you inherit the 401k as a child or are disabled.
Surviving Spouse
As a surviving spouse, you have four options when you inherit a 401k. You will want to consider the choices to pick the one that fits your needs.
- Lump Sum Distribution – A spouse may choose to take the 401k funds as a lump sum payment. However, the funds will be taxed as normal income and could slide you into a higher tax bracket.
- Roll the 401k Into Your Own 401k – You may opt to roll the inherited 401k into your own 401k. This allows you to continue to grow the funds. The same rules for withdrawal will apply as usual.
- Transfer 401k into Inherited IRA – If you also inherited an IRA, you are allowed to transfer the 401k funds into this account. This may allow you to withdraw funds at an earlier age, which is helpful if you are younger.
- Leave the 401k Alone – You can leave the 401k where it is. This option gives you access to withdraw the funds based on life expectancy. If you and/or your spouse were already taking RMDs, you may keep the payments as scheduled, or you may delay them until you are age 73.
Non-Spouse
A non-spouse who inherits a 401k has three main options.
- Transfer 401k into Inherited IRA – You may transfer an inherited 401k into an inherited IRA. You must withdraw all funds from the inherited IRA within ten years. You will generally owe taxes on IRA withdrawals unless it is a Roth IRA.
- Lump Sum Distribution – You may take a lump sum distribution, but the money will count towards income. This could result in paying a higher tax rate. If it is a Roth 401k, you will not pay taxes on withdrawals.
- Leave the 401k Alone – You may elect to leave the funds in the current 401k. You can withdraw it over a ten-year period. The ten-year rule applies to non-spouse 401k inheritances. You must deplete the inherited 401k within ten years.
Inheriting a 401k can be somewhat confusing. It is best to consult with an attorney to determine your options before you decide what to do. You want to make sure you follow the law and receive the money you inherited with as little tax implication as possible. To learn more, contact our legal team at Moen Sheehan Meyer, Ltd. at (608) 784-8310 or online.