If you inherit a 401k, there are certain things you need to know. In a perfect world, inheriting a 401k would be cause for celebration after the appropriate grieving process, of course. News Flash, we don’t live in a perfect world. If you inherit a 401k, you will no doubt have some decisions to make and some taxes to pay. Depending on the 401k, whether you are a spouse or non-spouse beneficiary and how the beneficiaries were named, this could be a nightmare or a pleasant experience. Professional assistance is recommended before making any decisions if you inherit a 401k.
When the holder of a 401k dies, the 401k becomes part of the taxable estate, however, the beneficiary might have access to the money even while the estate is in probate. If you are the spouse, you are permitted to roll the 401k into an IRA to avoid paying taxes until you start making withdrawals. If you are a non-spouse beneficiary, you will probably have to take the inheritance as a lump sum distribution and pay the income taxes. However, there won't be an early withdrawal penalty. If you roll the 401k over to an IRA, you shouldn't have the check sent to you. Rather, have the check sent directly to the financial institution. If the check is sent to you, the company might withhold the taxes since it might assume this is a lump sum distribution. There are different rules for just about every 401k plan so be sure to know what the plan allows before making your decision.
No matter whether you are a spouse or a non-spouse beneficiary, there are many tax implications and consequences that must be considered if you inherit a 401k. You should consider consulting a tax professional to help you through the red tape involved in inheriting a 401k plan.
A note for a plan participant:
If you are a participant in a 401k, you should take a look at your beneficiaries and make sure these are set up exactly the way you want. Your plan administrator can help you with this task. You should also keep a copy of your beneficiaries, your summary plan description, along with contact information for your plan administrator. This information will be invaluable to your heirs. If you maintain your 401k plan online, a copy of the website URL and your username and password should also be documented. This information is best kept in a secure place but your heirs need to know where it’s located.
A note for future beneficiaries:
If you are named beneficiary of a 401k plan, if at all possible, learn the rules for inheriting this plan prior to the death of the plan participant. This might sound awfully morbid but the time to learn the rules is before you need to do something. When a loved one dies, it's a very difficult time and you shouldn't be bothered with trying to understand financial implications of your actions. How ever you decide to handle an inherited 401k could have an impact on your financial well-being.