Inheriting a 401k: What You Need to Know

Inheriting a 401k: What You Need to Know


Grief is inevitable when a loved one passes away. If you are the beneficiary of that person’s 401k account, you will need to know certain things – especially for tax planning – regardless of how difficult it may be to focus on finances at such a time.

How the 401k is taxed

401ks are included in a person’s taxable estate when they die. Beneficiaries generally will not have to wait until probate is completed before receiving account balances.

According to Fred Mutter, tax manager at Deloitte and Touche, the beneficiary of the plan should be able to access the funds even while the rest of the estate is in probate.

The amount you receive (in) will be subject to income tax

There are different strategies you may be able to use in addition to estate taxes to spread out or delay the tax burden, particularly if you are the spouse.

Other factors also need to be considered. If a 401k account is subject to federal estate tax as well, which usually occurs if the taxable estate exceeds $650,000, you may be eligible for a federal income tax deduction. In 2006, we will raise $1 million (this amount is raised each year).

There Is No One-Size-Fits-All 401k Plan

What happens to your 401k When you die.You should realize that each 401k plan has its own rules when considering your options for receiving money as a beneficiary. The IRS sets the outside limits, but plans can be more restrictive than those general guidelines. It is possible that the IRS will allow you to leave your 401k inheritance in the account without touching it (or paying taxes on it), but the plan rules may require you to take it out sooner.

You should look at the 401k plan document to determine what rules will apply to your situation if you inherit someone’s 401k account. As this can be complicated, you should ask for help from a tax professional.

The rules may also differ depending on whether or not the deceased was your spouse and if he or she was already receiving periodic payments from the account.

A lump sum distribution is most likely

In most cases, you will need to withdraw the money from your account in one go, also known as a lump-sum distribution. A majority of plans will automatically kick out money, says Cindy McCabe, Senior Manager at

Deloitte and Touche Employee Benefits Tax Services. This is done for administrative reasons, so they don’t have to spend resources tracking down an employee who is no longer employed.

In addition to local, state, and federal income taxes, you will receive a lump sum. Even if you or the deceased person are younger than age 59 1 2 (the age at which account holders are allowed to withdraw money from their accounts without a penalty) you will not have to pay the 10% early withdrawal tax.