Inherited 401(k) - When and How You Can Take Money Out

Beneficiaries who inherit a 401(k) must follow the rules to avoid penalties.

Inherited 401(k) money in a jar.
To avoid penalties, follow the rules that apply to inherited 401(k) money. JGI/Jamie Grill/Getty Images

If you are the beneficiary of a 401(k) plan, or inherited a 401(k) plan, your choices as to how and when you are required to take the money out will depend on:

  • Whether you were the spouse of the deceased person, or a non-spouse
  • Your age and the deceased person’s age at death

Below is a guide to help you figure out what rules apply to you!

Spouse Beneficiary

First, let's look at the rules that apply if you are inheriting a 401(k) plan from your spouse.

If Your Spouse Was Over Age 70 ½ and You Are Over Age 70 ½

If your spouse was over age 70½ and thus had already started taking required minimum distributions at the time of death, and you are over age 70 ½, the rule is that you must, at a minimum, continue to take out at least the required minimum distributions. This could happen in a few ways.

  1. You can leave the money in the plan, continuing the distributions according to the required minimum distribution schedule that applied to your spouse. If you desire you can take out more than this amount, but not less. The beneficiary designations set up by your spouse continue to apply.
     
  2. You can roll the funds over to a specific type of account titled as an "Inherited IRA." With an Inherited IRA you would take required distributions based on your single life expectancy table. If you desire you can take out more than this amount, but not less. You would name your own beneficiaries with this option.
     
  1. You can roll the funds over to your own IRA, called a spousal IRA. With this option, you would take required distributions based on your age and the Uniform Lifetime Table. If you desire you can take out more than this amount, but not less. You would name your own beneficiaries with this option. For most people, this is the best option.

    If you and your spouse were about the same age, the choices above will result in about the same required distribution. However, rolling it over to your own IRA may provide additional choices for your future beneficiaries.

    You can check out a required minimum distribution calculator to calculate the amount you would be required to take. It is based on your age and the applicable table.

    If You Are Over Age 59 ½, But Under Age 70 ½

    If you are the beneficiary of your spouse’s 401(k) plan and you are over age 59 ½, but not yet 70½, you have a few choices:

    1. You can leave the funds in the plan. If your spouse was over age 70 1/2 and had started their distributions you continue taking these required minimum distributions each year, or you begin taking them at the time your spouse would have reached age 70 1/2. The beneficiary designations set up by your spouse continue to apply with this choice.
       
    2. You can roll the funds over to a specific type of account titled as an Inherited IRA. As an Inherited IRA you take required distributions based on your single life expectancy table. If you desire you can take out more than this amount, but not less. You name your own beneficiaries with this option.
       
    3. You can roll over the account into your own IRA. The potential advantage to this is you will not be required to start distributions until the calendar year after you reach 70½. This option provides additional flexibility because you can withdraw the money if needed, but you won't be required to withdraw it until you reach age 70 1/2. You name your own beneficiaries with this option. For most people, this is the best option.

      If your spouse was older than you, you need to project your current and future income tax rate to determine if it is best for you to delay distributions until your age 70 1/2, or continuing with the annual required distributions if your spouse had already been required to start taking them.

      Note: Additional IRA distributions may make more of your Social Security income taxable. It thus may be to your benefit to take more IRA distributions before your Social Security benefits start. A skilled retirement planner can help you determine your best course of action.

      If You Are Under Age 59 ½

      If you inherit a spouse’s 401(k) plan but you are not yet age 59 ½, consider the pros and cons of the following choices.

      1. You can leave the money in the 401(k) plan. With this option, you can take withdrawals as needed and the 10% penalty tax will not apply even if you have not yet reached age 59 1/2. You will still pay regular income tax on any amount withdrawn. (With this choice if your spouse was over age 70 ½, you will be required to continue the required minimum distributions.) The beneficiary designations set up by your spouse would continue to apply at your death.
         
      1. You can roll the funds over to a specific type of account titled as an Inherited IRA. With an Inherited IRA you take required distributions based on your single life expectancy table. You can take out more than this amount, but not less. With this option, withdrawals are not subject to the 10% penalty tax even if you are not yet age 59 1/2. You name your own beneficiaries with this option.
         
      2. You can rollover the 401(k) plan to your own IRA account. There will be no taxes on this transaction. However, if you are not yet age 59 ½, you may not want to do this, because once it becomes your own IRA, any distributions you take will be considered early distributions and subject to a 10% penalty tax as well as regular income taxes. You name your own beneficiaries with this option.

      For most people who are not yet age 59 1/2, the best option will be option 1 or 2 above.

      Non-Spouse Beneficiary

      If you are the beneficiary of someone’s 401(k) plan and they were not your spouse, there are three possible choices covered below.

      If The Person You Inherited From Was Over Age 70 ½

      1. If the person you inherited the account from was over age 70 ½, and thus had already started taking required minimum distributions at the time of death, the rule is that you must, at a minimum, continue to take out at least these required minimum distributions, and if you desire you can take out more than this amount, but not less. You can take these distributions out over the longer of either the decedent's life expectancy or your own, according to the IRS required minimum distribution life expectancy tables. You should have the option to do this by leaving the money in the plan or by rolling it over to an account titled as an Inherited IRA.

      If They Were Not Yet Age 70 ½

      If the person you inherited the 401(k) plan from was not yet age 70 ½, the 401(k) plan will allow one or both of the options below:

      2. The 401(k) plan may require you to take all of the money out of the plan no later than December 31 of the fifth year following the year of the person’s death. You could take a little out each year, or wait until the last year to take it all. You will pay regular income taxes on the amount withdrawn, so you may want to take more out in years where you expect to be in a lower tax rate.

      3. The plan may allow you to take the money out in annual amounts over your life expectancy according to the required minimum distribution life expectancy tables. You may be able to do this by leaving the money in the plan or by rolling it over to an account titled as an Inherited IRA. This option is often referred to as a "stretch IRA" because if you are much younger than the person you inherited from, you can stretch the distributions out over a long period of time.