What To Do With an Inherited IRA or 401(k)

Options for Dealing With a Retirement Account Inheritance

Man talking to financial advisor about an inherited 401(k)
Photo:

GARO / Canopy / Getty Images

Many people will inherit an individual retirement account (IRA) or 401(k) and wonder how to incorporate this inheritance into their finances. The next move is not only critical, but it's also time sensitive if you want to avoid a taxable event. Your options will vary, depending on whether you're the spouse of the account holder.

Key Takeaways

  • A spouse who inherits a lump sum can take all the assets at once, transfer them to their own IRA, or open an inherited IRA.
  • You have to take minimum distributions from the IRA by the end of the year your spouse died, or the year they would have turned 70½.
  • Children and non-spouses can choose an inherited IRA or a lump sum, but they must take required minimum distributions if an inherited IRA is chosen.

How Do You Inherit an IRA or 401(k)?

Those who inherit an IRA or 401(k) are the "designated beneficiaries" of an account. When an individual first opens an IRA or a 401(k) plan, part of the initial paperwork process is to name at least one primary and maybe even some contingent beneficiaries. When the account holder dies, the assets in the account are passed to these beneficiaries in the way that the account holder predetermined in the initial paperwork.

For example, an account holder might have a spouse and two children. Their spouse is the primary beneficiary of 100% of the IRA funds. Their two kids are each 50% contingent beneficiaries. This means that the spouse would inherit the full account upon the account holder's death. The assets would be divided between the children if the spouse were not alive to inherit or if they pass while receiving distributions from the account.

Note

You can check with the company that administers your plan if you don’t remember the beneficiaries you named to your own account. Many 401(k) and IRA providers are set up to let you do this online.

Inherited IRA or 401(k) Options for a Spouse

You have the most options when inheriting a 401(k) or an IRA if you're the spouse of the account holder. The first option, and possibly an individual's first instinct when dealing with an IRA or 401(k) that's been inherited, is to take the assets out all at once. This is known as a "lump sum distribution."

The lump sum must be included as part of your annual income when you're reporting on your tax return for that year. There may even be a mandatory 20% withholding for taxes when the money is taken out. The good news is the assets won't be subject to the typical 10% early withdrawal penalty that's normally imposed on the creator of the account.

Some spouses may instead want to keep the money growing tax deferred for their own retirement. A spouse has the unique ability to transfer assets to their own IRA, but non-spouse beneficiaries can't take this option. The withdrawal schedule and penalties for early withdrawal will fall under the typical ​IRA withdrawal rules.

The third option for a spouse is to open an "inherited IRA." This type of account would remain in the original owner's name for the benefit of their spouse. Just as with the other IRA option, the assets would continue to grow tax deferred until the money is withdrawn. The difference with this IRA option is that the funds can be accessed at any time.

Rules for Distribution

There are some very strict rules regarding when heirs must begin taking distributions. A required minimum distribution (RMD) is the amount that must be taken from the account each year during retirement, based on the age of the account holder or beneficiary, and on the size of the account.

Note

You can divide your account balance for the prior year by life expectancy to calculate your RMD.

If the account holder was younger than age 70½ when they died, their spouse would have to begin taking annual required minimum distributions either by the end of the year of the account holder's death or by the end of the year in which they would have turned 70½ , whichever date is later.

If the account holder was older than age 70½ at the time of their death, their spouse would have to take the annual RMD by the end of the year following the death. The exception is if the account holder was taking distributions at the time of their death. Their spouse would have to take the RMD in the year of their death in this case.

Note

The RMD may be required before the assets can be moved into a new IRA if the account is a 401(k).

Options for Children and Non-Spouses

You don't have the option to roll the account directly into your own if the IRA you inherit is from a parent or other non-spouse. But you can set up an inherited IRA and have the assets continue to grow tax deferred. Again, the account remains in the name of the original account holder for your benefit.

The RMDs are the same. You must take RMDs either by the end of that year or the end of the year in which the account holder would have turned 70½, whichever is later, if the holder of your account passed away before age 70½.

It may help to speak to a tax advisor as well as a financial planner to get a full view of how each affects your financial picture before deciding which option is best for you. Even a representative at the IRA fund company or a 401(k) administrator may be able to walk you through your options.

Frequently Asked Questions (FAQs)

Who gets to decide what happens with the account if there are multiple non-spouse beneficiaries?

Non-spouses also have the right to cash out, pay the taxes, and take the lump sum distribution. You can request to split the account and let each beneficiary decide what to do with their share if there's more than one beneficiary.

What happens if the account holder doesn't name a specific beneficiary?

It's possible to name a living trust or an estate as the beneficiary or contingent beneficiary of an IRA or 401(k). The asset would pass to the estate automatically if no beneficiary is named, and it must be distributed in less than five years in this case, according to Internal Revenue Service (IRS) rules.

Was this page helpful?
Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. IRS. "Topic 412 Lump-Sum Distributions."

  2. Charles Schwab. "Inheriting an IRA? Understand Your Options."

  3. IRS. "Retirement Topics: Beneficiary."

  4. IRS. "Required Minimum Distributions for IRA Beneficiaries."

  5. HG.org Legal Resources. "What Happens to an IRA With No Beneficiary Designation?"

Related Articles