How To Claim 401k After Death – Inheriting a 401(k) isn’t always as simple as inheriting a house or other types of assets. The IRS has detailed rules on 401(k) beneficiaries that say when they must take the 401(k) and how much tax they pay. 401(k) inheritance rules are complex and different for spouses than for other beneficiaries. If you are currently a beneficiary of a 401(k) or have recently inherited one, this guide will help you understand the important details you may need to know.
A legacy 401(k) is a 401(k) that is transferred to a beneficiary after the account owner’s death.
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A beneficiary is the person or entity that receives the inherited 401(k). If you are married, the beneficiary is usually your spouse. If you want to name someone other than your spouse, your spouse must sign a waiver.
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If you are single, the beneficiary is anyone you name, such as a child, sibling, relative or charity. If you haven’t named someone as a beneficiary, your account will go to your estate.
Distribution options depend on whether you are a surviving spouse or a non-surviving spouse. We will discuss both scenarios below.
When a spouse inherits a 401(k), they get more options than other beneficiaries. If you inherit a 401(k) from your spouse, what you do with the inheritance and the tax consequences may depend largely on your age. If you’re under 59, there are four options to consider: 1. Move the money into your retirement account. Only surviving spouses can roll an inherited 401(k) into their 401(k). Another option is to put it in an IRA. This can be a Roth IRA or a traditional IRA you already have, or you can open a new IRA. The money is treated as your money and there will be no tax penalty for the move.
When you reach the age of 72, you should start making withdrawals based on your life expectancy. If you don’t need the money right away, this might be the best option for you because the money can grow in the account until you need it.
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Keep in mind, however, that if you’re under 59 ½ and withdrawing money from that account, you may be subject to a 10 percent early withdrawal penalty.
2. Transfer funds to an inherited IRA. You can rollover 401(k) funds into an inherited IRA. An inherited IRA is an individual retirement account that holds rollover funds from an inherited retirement plan. You can withdraw from an inherited IRA without incurring an early withdrawal penalty. It might be a good idea if you’re not yet 59 ½ and want to access funds without penalty.
It’s important to note that you should not withdraw money directly from your 401(k) account. The rollover must be made directly from the old account to the inherited IRA, or you may owe a tax penalty on that money.
3. Take a lump sum distribution A lump sum distribution is when you withdraw all the money from your legacy 401(k) at once. This gives you a large amount of money immediately, which can be a good option if you need money now. You will not pay an early withdrawal penalty.
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However, you must pay taxes on those funds in the same year, and withdrawals may move you into a higher tax bracket, depending on the amount of distributions and your current income level. 4. Leave the money in the plan and make the required minimum distributions based on your life expectancy. This method requires you to take minimum required distributions from your 401(k) account based on your life expectancy. This can be calculated by dividing the total value of the inherited 401(k) by the distribution period next to your age on the IRS single life expectancy table.
Each subsequent year, you subtract one from the distribution period and divide the remainder by this new number. This allows you to spread your money over time and minimize the impact of inherited 401(k) funds on your taxes in a given year.
As part of the SECURE Act, non-spouse 401(k) beneficiaries can withdraw from the account whenever they want, as long as everything is withdrawn from the inherited 401(k) account by the end of the 10th year thereafter. This 10-year law is called the death of the account holder. If the account owner died in 2020 or later, the 10-year rule applies. If you don’t empty the account within 10 years, you’ll have a 50% penalty on any assets left in the account.
1. Rollover to an Inherited IRA For this option, you set up an inherited IRA and roll over money from your 401(k) into that account. There is no set amount to be taken each year. However, the account must be emptied at the end of 10 years. With an inherited IRA, you have more control over how your money is invested.
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If the inherited 401(k) was pre-tax and you roll it over to an inherited pre-tax IRA, you’ll pay ordinary income tax on the amount you withdraw. Be careful when backing up. If you get too much money from an inherited IRA, it may push you into a higher tax bracket.
If the inherited 401(k) is a Roth 401(k) and you roll it over to an inherited Roth IRA, you won’t pay taxes on withdrawals because Roth accounts grow tax-free. In this case, it is better to wait until year 10 before harvesting.
It is also possible to roll over a pre-tax 401(k) inheritance into an inherited Roth IRA and pay taxes on the conversion income in that tax year. You may want to do this if you are in a lower tax bracket during that year. This money will then begin to grow tax-free. A converted inherited Roth IRA still has minimum distribution obligations.
2. Take a lump sum distribution This means you will have access to the money quickly, but you will pay more taxes. This may also push you into a higher income tax bracket. If the inherited 401(k) is pre-tax dollars, you may have to pay federal and possibly state and local taxes when you withdraw that money. 3. Withdraw Funds Over a 5- or 10-Year Period You can choose to withdraw funds from an inherited 401(k) anytime, as long as all the money is in by the end of the fifth or tenth year after the account owner’s death. If the account owner died in 2019 or earlier, the 5-year rule applies. If they die in 2020 or later, the 10-year rule applies. 4. Take minimum distributions based on your life expectancy. This strategy is only applicable if the account owner died before 2020. If the account owner died in 2020 or later, only the following people can use this strategy: – Account owner’s minor children (until they reach the age of majority and then turn 10.) – The year rule begins ) – disabled or chronically ill – anyone who is not more than 10 years younger than the account holder at the time of death.
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If your inherited 401(k) is on the smaller side, you may want to roll it over to an inherited IRA, let it grow, and then take distributions at the end of the 10-year period. If your inherited 401(k) is large, you may want to take distributions over a 10-year period to avoid any drastic tax changes.
Also, if you plan to retire or move to a state with lower income taxes, you may want to wait to take money out of your 401(k). It is best to speak with a financial advisor or tax professional to determine which option is best for you based on your circumstances.
The 10-year rule does not apply to minors until they reach the age of majority (usually around 18-21 depending on state laws). After reaching the age of majority, they have to empty the account within 10 years.
You must pay ordinary income taxes (federal, state, local) when withdrawing money from an inherited 401(k) before taxes. You want to manage your tax bracket well and withdraw enough to fill the lower tax brackets, but not so much that you pay taxes in the higher brackets.
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There are tax consequences to inheriting a 401(k). You must pay income tax on any money you withdraw before tax. This may also move you into a higher income tax bracket depending on the amount received. This can complicate your tax situation, so it’s important to work with a financial advisor or tax professional.
If the 401(k) inheritance is pre-tax, you will have to pay taxes at some point after the money is withdrawn. You can lower your taxes by timing withdrawals during the years when you have lower taxes
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