If you are nearing retirement or have already retired, it’s important to know what will happen to your 401k and other retirement plans when you die. This is called estate planning. When a person dies with a 401K plan, their spouse (or other beneficiaries) can inherit the funds in the account and continue using them as they please. They need to make sure that they meet all IRS requirements for taking over ownership of an inherited 401K plan.
The Surviving Spouse
401(k) Rollover
When a spouse is the surviving primary beneficiary of a 401(k), they can choose to roll their deceased’s account into a new inherited IRA account or inherited IRA annuity. This will allow all tax-deferred income earned in this account to continue being deferred until the surviving spouse makes withdrawals.
They can also use their own life expectancy for taking required minimum distributions (RMDs). The surviving spouse can choose the beneficiary designations that will receive the account at the time of their death. Be sure to maintain and update the retirement plan’s beneficiary form.
Leave The 401(k) Alone
A surviving spouse can manage the inherited 401(k) as the deceased spouse’s account owner. The surviving spouse can defer withdrawals or withdraw from the 401(k), and they are exempt from the IRS early withdrawal penalty if the surviving spouse is younger than age 59½ at the time of death. However, if the deceased was age 70½ or older, the surviving spouse must take required minimum distributions (RMDs) from the inherited 401(k).
How To Provide Your Surviving Spouse An Income For Life
Referring back to the Rollover option, you can rollover your 401(k) into a deferred annuity with an income rider now while you’re alive. Utilizing this method will allow both spouses to generate an income for the rest of their lives, even if the 401(k) ran out of money, solidifying any doubt in your financial situation now or in the future.
Non-Spousal Beneficiary
You have two options.
- Inherited IRA: Non-spousal beneficiaries will be required to begin taking RMDs by December 31 of the year following the deceased owner’s death if you elect this option. The distributions would be calculated over their own life expectancy. Additional amounts can be taken out as needed. The total distribution amount would be included in taxable income each year a distribution is taken.
- Cash-out, Lump-Sum Distribution: The entire inherited 401(k) would be taxable income if this option is chosen. The lump-sum would be treated as ordinary income taxes.
Estate Taxes
If you die leaving assets, the total value exceeds your estate’s exemption limit; then, your estate would have to pay a federal or state tax on the additional amount.
How To Minimize The Tax Burden
401(k) Owners:
- Rollover the 401(k) into an annuity with an enhanced death benefit is a good idea. These enhanced death benefits increase the annuities value at the time of death to help offset the sizeable tax burden a non-spousal beneficiary may receive at the time of your death.
- Another good option is to fund a life insurance policy with required minimum distributions from the 401(k).
Non-spousal beneficiaries:
- Cash Out 401(k): Roll the 401(k) in an inherited IRA annuity with a premium bonus to offset the taxes.
- Spread The Distributions: Roll the 401(k) into an annuity and annuitize the contract to receive an income after the taxes have been paid to the IRS. You can make the tax money back from the income generated by the annuity.
I’m a licensed financial professional. I’ve sold annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.
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