A 401k is a popular employer-sponsored retirement savings account that allows employees to contribute a portion of their paycheck before taxes are taken out. The money invested in a 401k grows tax-deferred, meaning no taxes are paid on the growth until funds are withdrawn in retirement.
Many people invest a significant amount of money into their 401k accounts over the course of their careers to build up a healthy nest egg for retirement. A natural question that arises is what happens to the 401k account when the account owner passes away? Can the remaining 401k balance be passed down to children or other beneficiaries?
Can 401k Be Inherited?
The short answer is yes, 401k accounts can be inherited by beneficiaries upon the death of the account owner. The 401k does not simply disappear or revert back to the employer when someone passes away. Instead, the 401k balance left in the account at the time of death can be passed on to whomever the account owner designates as beneficiaries.
401k plans allow account owners to name one or more beneficiaries on the account. These beneficiaries are named either when the 401k account is originally set up or can be changed later on. The designated beneficiaries will receive the 401k assets after the death of the account owner.
401k Beneficiary Rules
While 401k accounts can be passed down to heirs, there are specific 401k beneficiary rules that must be followed to transfer the assets properly:
- Beneficiaries must be named – In order for assets to be transferred, one or more beneficiaries must be named on the 401k account. If no beneficiary is named, the 401k will end up in probate which will slow down the transfer process.
- Spousal beneficiaries have special options – A spouse who inherits a 401k has more flexibility than other beneficiaries. They can rollover the 401k into their own IRA account, take lump sum distributions, or treat the inherited 401k as their own.
- Non-spouse beneficiaries have stricter rules – Other beneficiaries like children or other relatives cannot rollover the 401k into their own accounts. They must take distributions from the inherited 401k over a 10 year period.
- 401k assets don’t bypass estate taxes – While 401ks can pass directly to beneficiaries, they are still subject to estate taxes before being distributed to heirs if the estate exceeds federal estate tax limits.
Following the specific 401k beneficiary regulations ensures the smooth transfer of 401k assets to the recipients named by the account owner.
Who Can Be a 401k Beneficiary?
401k account owners have flexibility when designating 401k beneficiaries. Beneficiaries can include:
- Spouse – Married account owners almost always name their spouse as the primary beneficiary on 401ks. This ensures assets pass to the spouse at the death of the first spouse.
- Children – Minor children can be listed as beneficiaries, either individually or collectively as a group. Most states require inherited assets to be held in a custodial account until children reach age of majority.
- Other family members – Parents, siblings, domestic partners, etc. can be named as beneficiaries. Proper estate planning should be used to minimize taxes on larger accounts.
- Trusts – 401k assets can be transferred to a trust set up by the account owner. The trust dictates how assets are managed and distributed to beneficiaries.
- Charities – Tax-exempt organizations like charities can be listed as 401k beneficiaries. This provides an estate tax deduction for larger accounts.
401k account owners should carefully weigh their specific situation including tax considerations when naming beneficiaries. It’s also important to review and update beneficiaries regularly after major life events.
Can Children Inherit 401k from Parents?
Now that we’ve covered the basics, let’s specifically look at whether 401k accounts can be inherited by children when a parent passes away. The short answer is yes, you can name your child or children as the beneficiaries on your 401k account.
Listed below are some key considerations around leaving a 401k to children:
- No age requirements – Minor children can inherit a 401k as long as proper custodial accounts are set up for them.
- No cut-off for adult children – 401ks can be left to adult children of any age. Children do not have to be minors or dependent to be beneficiaries.
- Equal or unequal distribution – 401k assets can divided equally or unequally between multiple children per the account owner’s wishes.
- Special rules apply – As noted earlier, children who inherit a 401k must take distributions from the inherited account over 10 years. They cannot rollover or treat as their own.
- Tax implications – Withdrawals from an inherited 401k are subject to ordinary income taxes. Careful planning can help minimize tax burdens.
In most cases, naming children as 401k beneficiaries can be an efficient way to transfer wealth to the next generation. Consulting with financial and legal advisors can help ensure your specific objectives are met.
401k Inheritance Rules for Spouses vs. Non-Spouses
401k inheritance rules differ depending on whether the beneficiary is a spouse or a non-spouse. Below is a comparison of the options for spousal vs. non-spousal 401k beneficiaries.
401k Inheritance Rules for Spouses
- Can rollover 401k assets into own IRA
- Can treat inherited 401k as their own
- Can take lump sum 401k distribution
- Must start RMDs at age 72
401k Inheritance Rules for Non-Spouses
- Cannot rollover 401k into own account
- Must take RMDs over 10 years
- Withdrawals subject to ordinary income taxes
- Must start RMDs by December 31 of year after death
As the table illustrates, spousal beneficiaries of a 401k have more options like being able to rollover the assets into their own retirement accounts. Non-spouses like children have stricter limitations but can still inherit 401k assets.
Taxes on Inherited 401k Accounts
Taxes can significantly impact the amount of inherited 401k assets beneficiaries end up with. Below are some key tax rules on inherited 401ks:
- Inherited 401ks do not receive a stepped-up cost basis for capital gains
- Beneficiaries pay ordinary income taxes on withdrawals
- RMD amounts each year are subject to ordinary taxes
- Withdrawals may push beneficiary into higher tax bracket
- Estate taxes apply before transfer if estate exceeds federal limits
Proper planning around the tax implications can help beneficiaries minimize how much of the inheritance is lost to taxes. Steps like timing withdrawals or converting to Roth IRA accounts can reduce tax burdens.
Maximize 401k Inheritance with Proper Planning
To ensure your loved ones receive the maximum inheritance from your 401k, it’s important to proactively plan:
- Name individual beneficiaries – Clearly designate desired beneficiaries on the 401k rather than vague terms like “children.”
- List contingent beneficiaries – Name back-up beneficiaries in case the primary beneficiaries pass away first.
- Consider partial Roth conversion – Paying taxes now can minimize future taxes for beneficiaries.
- Evaluate trusts or charities – These options may provide tax advantages in some cases.
- Review beneficiaries regularly – Update as needed after major life events like marriage or divorce.
Meeting with financial and legal professionals can provide guidance to ensure your specific 401k inheritance objectives are achieved.
Frequently Asked Questions
Can a spouse claim inherited 401k on taxes?
A 401k inherited from a deceased spouse can be treated differently on taxes depending on the choices made by the surviving spouse:
- Rollover to own IRA – No tax impact until withdrawals taken later.
- Treat as own 401k – Pre-tax contributions remain tax deferred.
- Take lump sum – Subject to ordinary income taxes in year received.
A financial advisor can help determine the best approach based on the surviving spouse’s specific situation.
What happens if no 401k beneficiary is named?
If no beneficiary is named on a 401k account, the assets will end up in probate after the account owner dies. The 401k will then be distributed either according to the instructions in the will or state laws if no will exists.
This default process takes much longer than directly transferring to named beneficiaries. Additionally, 401k assets may be taxed at higher ordinary income tax rates when no beneficiary is listed.
Do 401k beneficiaries have to pay estate taxes?
While 401k accounts pass directly to beneficiaries outside of probate, they are still subject to federal estate taxes prior to distribution to heirs:
- Estate taxes apply if estate exceeds $12M (2023)
- 401k balance is included in calculating taxable estate
- Taxes up to 40% levied on estate value over limit
Estate taxes can claim a significant portion of larger 401k balances being transferred to heirs. Proper estate planning is key to minimizing taxes.
Can I disinherit a child from 401k?
401k account owners can specifically exclude a child or other relative as a beneficiary. Steps include:
- Naming other beneficiaries on 401k designation form
- Stipulating disinheritance in will or living trust
- Setting up 401k trust that excludes certain heirs
It is important to work with an estate planning attorney to properly document the disinheritance to avoid disputes. Account owners should be clear on their intentions.
The Bottom Line
401k accounts can be an excellent vehicle to pass on hard-earned retirement savings to the next generation. Account owners should take the time to properly designate beneficiaries, coordinate with other estate planning, and consider potential tax implications to ensure their wealth transfer objectives are achieved.
While there are specific rules around 401k inheritances, the assets do not simply disappear when the original owner passes away. With sound planning, 401k balances can be successfully transferred to children and other beneficiaries to provide lasting financial benefits.