When you think of inheritance, what comes to mind? If you’re like most people, you probably think of a bank account, maybe a house or some family heirlooms. But since any and all assets someone owns can be left to another person as inheritance, there’s another type of inheritance that many Americans may find themselves having to deal with: an inherited 401(k) account.
When you inherit a 401(k) from a spouse, a parent, or another benefactor, it can come with some unique situations. You might wonder what it will mean for your financial situation. You might not be sure what you can do with this sort of inheritance. Read on to learn what you should do if you inherit or are going to inherit this type of account.
What is a 401(k) account?
A 401(k) account is a retirement savings account. Sponsored by an employer, a person can put part of each paycheck into their 401(k) account. Their employer will sometimes contribute the same amount to – or match – the 401(k) deposit. The income taxes that are typically taken out of a paycheck aren’t taken out until the 401(k) contribution has been withdrawn. This means an account holder doesn’t pay income taxes on the amount they put into their 401(k). The money is not tax-fee however. These types of accounts are created as retirement savings accounts, to be ‘cashed in’ at a later time. Funds in a 401(K) account are taxable when the money is withdrawn.
Why does someone create a 401(k) account?
A 401(k) is a long-term investment strategy that helps working adults save for retirement and fund expenses they expect to have once they stop working. Though a 401(k) savings account is employer-backed, it is not the same thing as a pension. Some workers expect to receive a pension in addition to their retirement savings account, some will rely solely on their savings and investments when they retire (especially if they retire before Social Security age.) Since a person may have been adding to their 401(k) account for their entire working life, these accounts can become sizable by the time retirement age approaches.
What happens if you inherit a 401(k) account?
Even if you have been contributing to a 401(k) account of your own, knowing what to do when you become the recipient of someone else’s retirement savings account after their death can be confusing. And if a 401(k) is included among other assets – left in Trust or bequeathed in a Will – the management of it can differ from other assets. What you can do with your inherited 401(k) can depend on:
If you are the beneficiary
The beneficiary of the account is set up when the account is created. This may be changed by the account’s owner at some point (maybe after getting married or divorced) but is a definite term of the account. The beneficiary assigned to the 401(k) overrides any beneficiary named in a Will. Other bank accounts such as savings or checking accounts may be left as assets in a person’s Will, but a 401(k) account will have a beneficiary attached to it. If you are the beneficiary of a 401(k), or one of several beneficiaries, you will receive it as a taxable inheritance when the account holder dies.
If you’ve inherited a 401(k) from your spouse
If your husband or wife has left you their 401(k) account, you have the option to roll it over to your own separate 401(k) account. Consolidating the two accounts is possible only when the beneficiary is a spouse. Another option is to withdraw the money that’s in the account, and pay income taxes on it when you do.
If you’ve inherited a 401(k) from another benefactor
When you’ve inherited a 401(k) from another person – maybe a parent, relative, or companion – you will inherit the amount of money that’s in the account, and will have to withdraw the money from the account to receive it. If you are not a surviving spouse, you cannot add it to a 401(k) account that you currently have. 401(k) inheritance will be included on your income tax for the year you receive it.
If you want to withdraw the money from a 401(k) now or later
As the beneficiary of a 401(k), receiving the money in the account is fairly straightforward and doesn’t have to undergo the probate process that some other inherited bank accounts and assets can require. Getting access to the funds should be fairly quick. But you don’t have to withdraw money from a 401(k) account that you’ve inherited right away. In most cases (unless you are the surviving spouse), you can adhere to the 401(k)’s 10-year rule, which applies to 401k accounts that are inherited after 2020. This rule says that the account must be empty ten years after the date the account was inherited. Upon inheriting the account, you can withdraw all of the money at once, all of the money at some point within 10 years, some of the total money each year for up to ten years, half now and half next year, or some other combination so long as the account is empty 10 years from when you inherited it.
What an inherited 401(k) account means for your estate
The amount of money in a 401(k) account can be a sizable inheritance. Whether you take it as a lump sum, withdraw a set amount over several years, or add it to your 401(k), inheriting a 401(k) will have implications for your estate, including:
Taxes that you will owe on the 401(k) you’ve received
The income amount that you will show for the year (or years) you withdraw from the account
Financial assets added to your current bank accounts
A possible change to your own 401(k) account and its beneficiary
and more. Consulting with an estate planning attorney and a financial advisor can help you navigate inheriting a 401(k) and decide how to best manage your inheritance.
At Trust & Will, that’s what we’re here for. We make customizable, online estate planning not only possible, but simple. Find the state-specific estate planning online documents you need to create a Will or a Trust and make managing inheritance simple. If you’ve inherited a 401(k), contact us today to learn more about what you can do next.
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