What Happens To Your 401k When You Die?

The straightforward answer to this question is that your 401k will go to your named beneficiary(s) upon your death. Beneficiaries can be grouped into several categories. Your primary beneficiary is the first person that the account will go to upon your death.

A contingent beneficiary is who your account would go to should your primary beneficiary pass away before you, at the same time as you, or decline the inheritance altogether. Within each of these categories, you can designate multiple individuals or entities should you wish to split up the inheritance.

For example, your spouse and children could be your primary beneficiaries with an 80/20 split respectively. If god forbid your spouse and children passed away before you, with you, or simply declined the inheritance, the funds would then go to your contingent beneficiary such as your favorite charity.

In other words, a contingent beneficiary can be thought of as a backup beneficiary to your primary beneficiary(s). Beyond primary and contingent beneficiaries, 401k beneficiaries are also separated into spousal and non spousal beneficiaries.

It is important to stay up to date on your 401k beneficiary designations especially during major life changes such as marriage for example. The beneficiary designations for your 401k supersede any contrary instructions in a will or trust and if no beneficiary is named, the account will go into your estate.

Once your designated beneficiary(s) inherit your account, there are rules that dictate how they can use the funds. Factors that impact these rules can include the beneficiary(s) relationship to yourself, the rules of the specific plan, the age of the beneficiary, the year that you died and more.

Option 1 - Leave the money in the plan

In 2024, spousal beneficiaries can elect to leave the assets in their inherited 401k. The beneficiary will be treated as if they are the account owner for purposes of calculating required minimum distributions and the RMDs respective start date. RMD rules will be covered in more detail later on.

Spousal beneficiaries may choose this option if they do not have another account to roll the funds into and are not yet ready to take distributions. In other words, it will allow a spousal beneficiary to leave the funds in a tax advantaged account. Keep in mind that not all plans allow this so it is important to be aware of specific plan rules.

Option 2 - Roll the money to a 401k or IRA

The second option for a spousal beneficiary is to roll their inherited 401k into an existing IRA that is in their name or into another qualified retirement plan such as their own 401k or similar account. This allows spousal beneficiaries to retain more control of their inherited 401k by moving the assets into an account they already have established.

Option 3 - Take a lump sum distribution

The third option available to spousal beneficiaries is to take an immediate lump sum payment from the inherited 401k. If the account is a Traditional 401k, the entire distribution will be taxable as ordinary income, but the early 10% withdrawal penalty is waived even if the beneficiary is younger than 59 and a half.

Option 1 - Roll to an Inherited IRA

The first option available to a non-spousal beneficiary is to roll an inherited 401k into an inherited IRA. Spousal beneficiaries may not roll an inherited 401k into an IRA that they already have or another qualified retirement plan that they already have.

If a non-spousal beneficiary opts for this option, they are not allowed to make additional contributions into the inherited IRA. An inherited IRA may allow a non-spousal beneficiary to have access to a broader range of investments through the IRA, but ultimately inherited IRAs are used for distribution purposes.

Option 2 - Take a distribution

Similar to spousal beneficiaries, non-spousal beneficiaries have the option to take a lump sum distribution from their inherited 401k. Lump sum distributions are taxable as ordinary income for the non-spousal beneficiary, but the 10% early withdrawal penalty does not apply.

Additionally,  non-spousal beneficiaries may be able to establish lifetime installments from the account. However, there are a couple of exceptions that non-spousal beneficiaries should be aware of. The first is the five year rule.

The five year rule requires that the non-spousal beneficiary pull all funds out of the account by the end of 5 years if the account owner passed away prior to January 1, 2020. The second is the ten year rule.

If the account owner died after January 1, 2020, and the non-spousal beneficiary is more than 10 years younger than the account owner, the non-spousal beneficiary is required to pull all funds out of the account by the end of the 10th year.  

When a beneficiary inherits a 401k, whether a spousal or non-spousal beneficiary, the tax rules that apply to the account will apply to the beneficiary. In other words, when a beneficiary takes a distribution they will incur ordinary income taxes on the total withdrawal amount, unless the account is a Roth 401k and specific rules are met.

Taking a lump sum distribution can easily drive a beneficiary's income into a higher tax bracket. Taking distributions over time can help lower a beneficiary's taxable income, but beneficiaries should always consult with a tax professional to come up with a tax efficient strategy when dealing with their inheritance.

RMDs, or required minimum distributions, are the minimum amount a 401k account holder must take out of their 401k once they turn 73 years old. The required beginning date, or RBD, is when account owners must begin taking withdrawals from their account.

The RMD rules that affect beneficiaries will depend if the account owner passed away before or after their required beginning date (RBD). If the account owner passed away before their RBD, beneficiaries can follow life expectancy RMD rules, or the 5 or 10 year distribution rules depending on what type of beneficiary they are.

If the account owner passed away after they reached their RBD, beneficiaries are required to receive the "year of death" RMD if it was not fully satisfied by the account owner. For subsequent years after the death of the account owner, beneficiaries must receive and continue to receive RMDs based on life expectancy if the account owner passed away prior to January 1, 2020.

If the account owner passed away on or after January 1, 2020, the beneficiaries would still use the life expectancy rule unless the beneficiary is using the 10 year rule. If the beneficiary is using the 10 year rule, RMDs in subsequent years do not need to be utilized. The account simply must be distributed by December 31st of the 10th year after the original account owner passed away.  

Always keep in mind that your 401k may have rules that limit the options discussed above or are different. It is important to be aware of what your plan will and will not allow you to do. You can contact your plan record keeper to get the specifics on what will happen to your specific 401k when you die so yourself and your beneficiaries are prepared.