What to do With Retirement Accounts After Death

The U.S. government created retirement accounts as investment vehicles for people so they could save more of their income to pay for their lives after they stop working. These savings accounts can be employer-sponsored, as is the case with a 401(k) plan, or they can be self-driven, such as Individual Retirement Accounts (IRAs).

The Internal Revenue Service (IRS) has rules that regulate retirement plans, giving guidelines for maximum yearly contributions, laying out penalties for early withdrawals and setting mandatory distribution amounts based on the age and life expectancy of the account holder.

The Beneficiary

When the owner of a retirement account dies, the account can be bequeathed to a beneficiary — any person or entity the owner chose to inherit the funds. If the account owner chose no beneficiary beforehand, the estate usually inherits the account.

The flexibility that a beneficiary has with an inherited retirement account and the tax consequences that accompany the bequest depend on many factors. The IRS’s array of rules and options are based on:

• The type of IRA (traditional or Roth)
• Whether a beneficiary was designated
• Whether the account holder died before or after the beginning date of “required minimum distributions” (RMDs)
• Whether the account’s sole beneficiary is a surviving spouse or widow

Understanding the complexity of choices that face a retirement account beneficiary is central to satisfying IRS mandates and maximizing the financial advantages of any inherited money. Owners and future beneficiaries of retirement accounts should seek professional advice before taking any action regarding them.

Inheriting an IRA

When inheriting an IRA, beneficiaries have several options. Those depend on their relationship to the original account owner.

A surviving spouse has more flexibility than other beneficiaries and can treat the inherited IRA as their own by designating themselves as the account owner. This action allows them to make contributions, name new beneficiaries, and withdraw funds anytime, although withdrawals before age 59½ incur a 10% penalty.

Alternatively, a surviving spouse can transfer inherited funds into their personal retirement account, be it an IRA or a 401(k). This transfer preserves the money’s tax-deferred status.

A third option is to treat themselves as a beneficiary and withdraw funds as desired, paying income taxes on distributions.

Non-spouse beneficiaries have fewer choices. They can:

• Cash out and pay taxes immediately
• Use the 5-Year Rule if the owner died before 2020
• Take distributions over 10 years under the 2019 SECURE Act rules
• In limited cases, take annual lifetime distributions

Complex trust and estate rules will probably affect the wisdom of these options.

Options for a Surviving Spouse

A surviving spouse who is the sole beneficiary of a retirement account has several choices. According to IRS rules, he or she can treat the IRA as their own, roll the account into another similar account, or continue as the beneficiary. Let’s examine these.

Treat the IRA as His or Her Own

A surviving spouse can designate himself or herself as the account owner. All the standard rules applying to the account would then apply to the surviving spouse. The spouse could then make contributions and withdrawals and name new beneficiaries. Withdrawals are subject to a 10% federal income tax penalty if the spouse has not reached age 59½. Required minimum distributions begin at 70½.

When someone withdraws or distributes money from the account, all nondeductible amounts are taxed as gross income. In addition, if someone doesn’t take a required minimum distribution according to IRS rules, the IRS levies a 50% excise tax on the amount that should have been withdrawn. (This penalty applies to all beneficiaries.)

Roll the Account Over into His or Her Own Retirement Account

Some retirement plans require a deceased employee’s account to be distributed in a lump sum. To avoid an immediate tax obligation, a surviving spouse could roll over the account into his or her own IRA or other retirement plan. (Surviving spouses have 60 days after the death to roll over the money.) Required minimum distributions would begin when the surviving spouse turns 70½.

Continue as the Beneficiary

This option works best if an individual dies before the age of 70½ and the surviving spouse has not reached 59½. The bank would delay required distributions until the deceased person would have had to make them. The surviving spouse would be able to withdraw funds without incurring the 10% early withdrawal penalty. Once the surviving spouse reaches age 59½, the account can be rolled over.

A surviving spouse can also choose the 5-Year Rule option if the spouse died before age 70½. This election requires the surviving spouse to withdraw all the funds by December 31 of the fifth year following the death.

If a surviving spouse is not the sole beneficiary, other rules would apply. In addition, the guidelines are different if the inherited account is a Roth IRA or another plan on which taxes have been pre-paid. Again, it’s best that the survivor consult the plan’s sponsor, a financial expert or a tax expert before making any decisions.

» Learn More: Inheriting Debt

Other Non-Spouse Beneficiaries of Inherited IRAs

Non-spouse beneficiaries have different options and restrictions.

They can choose:

• To cash out the account and pay taxes on the distribution.
• The 5-Year Rule payout option if the account holder died before age 70½.
• To treat the account as an inherited IRA, which would require minimum distributions to be taken by December 31 of the year following the account owner’s death.

Non-spouse beneficiaries cannot roll over an inherited IRA into their own account, nor can they treat the IRA as theirs. In addition, non-spouse beneficiaries could be liable for paying estate taxes if the value of the inherited IRS plus other inherited assets exceeds estate tax exemptions.

Distribution rules of some revocable trust are extremely complex, requiring expert legal assistance.

No Designated Beneficiaries of Inherited IRAs

If an account holder did not designate a beneficiary, typically the account would become part of the estate to be dispersed through probate court. If the account holder died before age 70½, the resulting beneficiary would be required to use the 5-Year Rule.

If the account holder died after the required minimum distributions had begun, the distribution period for the beneficiary would be based on the deceased’s age and distribution schedule.

Inheriting a 401(k)

Inheriting a 401(k) differs from inheriting an IRA in a few key ways.

For starters, 401(k) plans are an employer-sponsored, tax-advantaged retirement savings plan. Employees can contribute pre-tax or after-tax funds, such as to a Roth 401(k), which accumulate over time to fund retirement.

However, an IRA is an individual account not tied to an employer. Rules, distribution options, and tax treatment differ, depending on if you inherit a 401(k) or an IRA.

Upon opening a 401(k), the account owner typically names their beneficiaries on a 401(k)-beneficiary designation form. If the original account owner is married, the primary beneficiary is typically the surviving spouse. However, if the account owner is unmarried or the surviving spouse waives his or her right to inherit the 401(k), the account can be left to whomever the account owner designates. That includes siblings, children, other relatives, or even a trust or charity.

As a beneficiary, you must decide how you want to receive the inherited 401(k) funds. Your options depend on:

• Your relationship to the deceased (account owner)
• When the account owner died
• Account owners age at death
• Your health
• Your age in relation to the account owners age at death
• What the 401(k) plan allows

Understanding how inheriting a 401(k) works is vital to making informed decisions about managing the account and avoiding unnecessary taxes or penalties. Experts recommend consulting a financial professional when navigating the complex guidelines.

Options for a Surviving Spouse

401(k) plans have fewer payout options compared to inherited IRAs. The choices also depend on whether you are a surviving spouse or another beneficiary.

Surviving spouses have more flexibility, including the option to roll over the funds into their own retirement account. Non-spouses have stricter IRS distribution rules they must adhere to.

Also, if the person inheriting the 401(k) is a minor, disabled, chronically ill, or not more than 10 years younger than the decedent, different distribution rules will apply.

If a surviving spouse inherits a 401(k), they have four options:

• Take a lump-sum distribution
• Roll the money into their existing IRA or 401(k)
• Transfer it to a new IRA
• Leave the money where it is.

Take a Lump Sum Distribution

This option gives immediate access to the full account balance without incurring an early withdrawal penalty. This option is only attractive if you need immediate access to all the money immediately.

The spouse must pay income taxes on the distributions in one tax year. This could cause the spouse to get pushed into a more expensive tax bracket and lose more of the inheritance to the government.

Roll Inherited 401(k) Directly Into Your Own 401(k) or IRA

Rolling the inherited 401(k) into the surviving spouse’s IRA allows the money to grow tax deferred. However, regular IRA and 401(k) distribution rules then apply, including potential 10% early withdrawal penalties if accessing funds before age 59½.

Required minimum distributions (RMDs) from the rolled-over account begin at age 73 based on your life expectancy. Rolling over the inherited 401(k) does not incur penalties, although the spouse probably will owe tax if they convert a traditional 401(k) to a Roth 401(k) or a Roth IRA.

Transfer Funds Directly From the 401(k) Account Into a Newly Created IRA

Creating an inherited IRA preserves the 401(k)’s tax-advantaged status while giving the flexibility to take penalty-free withdrawals at any age. With this option, the account remains separate from the spouse’s own retirement savings.

However, the required minimum distributions are still required for inherited IRAs. This option enables the surviving spouse beneficiary to access funds without penalty while retaining the account’s tax benefits.

Leave the Inherited 401(k) Where It Is

This option allows the funds to keep growing tax-deferred, although the spouse must take RMDs from the account based on life expectancy. If the surviving spouse is at least 59½, he or she can choose to continue with the payment or to delay taking RMDs until they reach age 73, even if the deceased was already taking distributions. That option lets the surviving spouse take penalty-free withdrawals as desired between ages 59½ and 73. After age 73, RMDs are mandatory.

Other Beneficiaries of Inherited 401(k)s

Non-spouse beneficiaries like parents, siblings, friends, a legal guardian, etc., can inherit 401(k) accounts. However, options are limited compared to surviving spouses. For example, non-spouse beneficiaries can’t roll over inherited 401(k) funds into their accounts.

Also, the 2019 SECURE Act imposes a 10-year rule requiring non-spouse beneficiaries to empty an inherited 401(k) within 10 years of the death, with limited exceptions. Only minor children of the deceased, chronically ill or disabled people who are within 10 years younger of the account owner at death can take RMDs based on their life expectancy.

Options for non-spouse beneficiaries include taking a lump-sum distribution, transferring funds to a newly created IRA account, and leaving the money where it is to withdraw it over the next decade. Let’s look at the details.

Take a Lump Sum Distribution

Similar to a surviving spouse, a non-spouse beneficiary can withdraw the entire account balance immediately after inheriting the 401(k). However, the recipient would owe taxes at ordinary income rates on the withdrawal if the inherited 401(k) is pre-tax. If the inherited account is a Roth 401(k), then the withdrawal will not attract any income taxes. This option provides quick access to funds but eliminates future tax-deferred growth.

Transfer Funds Directly From the 401(k) Account Into a Newly Created IRA

This preserves the account’s tax-deferred status while giving some flexibility on withdrawals. However, inherited IRAs have faster required minimum distribution schedules for non-spouse beneficiaries. Most non-spouses are required to empty inherited IRAs within 10 years as per the SECURE Act. Taxes apply upon withdrawing from a pre-tax 401(k) whereas there are no tax implications upon converting or withdrawing from a Roth 401(k).

Leave the Money in the 401(K) and Withdraw It Over 10 Years

A non-spouse beneficiary can also choose to leave the money in the original account. However, as per the SECURE Act, non-spouse beneficiaries who inherit a 401(k) must empty the account within 10 years of the original owner’s death. This option allows the funds to continue growing tax-deferred over the decade before withdrawal.

No Designated Beneficiaries of Inherited 401(k)

If the original 401(k) account holder dies before naming any beneficiaries, the remaining funds typically go to the person’s estate. From there, if the deceased did not have a will, the money may go through probate and be distributed according to local inheritance laws.

Whoever eventually gets the 401(k) funds has a few options but must empty the account within five years if the original owner died before 2020 or within 10 years if they died more recently, because of SECURE Act rules.

Inheriting Social Security Accounts

Social Security provides monthly income for eligible retirees and disability beneficiaries, thanks to dedicated payroll taxes paid by workers and employers fund. A worker can earn up to four work credits each year. Each credit amounts to $1,640 of wages or self-employment income in 2023.

When a Social Security beneficiary dies, certain survivors like spouses, minor children, and sometimes parents or adult children disabled prior to age 22 may claim Social Security survivor benefits based on the deceased’s lifetime work credits.

The number of credits needed for the survivors to get benefits depends on the age of the worker at the time of death. Forty credits (or 10 years of work) are more than enough to be eligible for Social Security benefits. The younger a person is, the fewer credits they need. Consult SSA claims representatives to learn more about the work credit requirements for your situation.

However, Social Security benefits are not directly inheritable. Adult children cannot inherit a deceased parent’s benefits. The one exception is for adult children who have a qualifying disability.

Options for a Surviving Spouse

If someone who worked long enough to qualify for Social Security benefits dies, the surviving spouse may qualify for Social Security survivors’ benefits if the surviving spouse is at least 60 years old (or 50 if disabled).

Benefits can include continuing payments at 71.5% to 100% of the deceased’s benefit amount. The benefits paid out depend on the surviving spouse’s age, the amount the deceased worker qualified for based on their earnings history, and if the surviving spouse cares for any qualifying children.

If caring for the deceased’s child under age 16, a surviving spouse can receive benefits at any age until no longer caring for the child.

There’s also a $255 lump-sum death payment paid to the surviving spouse if they lived together or to an eligible child.

Benefits can continue unchanged if the surviving spouse remarries after age 60 (or 50 if disabled). Also, if the survivor is also entitled to benefits from their personal work history, they would receive the higher of the two amounts rather than a combined spouse/survivor benefit. A surviving divorced spouse can collect benefits if the couple was married 10 years or longer.

It is also important to note that benefits paid to a surviving spouse do not reduce payments to other eligible survivors. A surviving spouse can also qualify for excess survivor benefits up to a family limit if total benefits exceed that threshold.

Options for Other Beneficiaries

While a surviving spouse may receive monthly Social Security survivor benefits, other adult beneficiaries like children usually cannot inherit Social Security income directly from a deceased parent or family member.

The exceptions are:

• Disabled adult children who became disabled before age 22 may qualify for survivor benefits based on a parent’s work history.
• Unmarried minors under age 18 (or 19 years old if still in high school) may also receive survivor benefits until they reach the age of majority.

• Dependent parents age 62 and older who relied on the deceased for at least half their support can collect.

Benefits for minors typically end at age 18 or 19 if still in high school. However, disabled adult children can receive lifelong benefits if they remain unmarried. Benefit amount offered also depends on deceased’s work history and age at death.

Bottom Line, Inheriting Accounts Can Be Complicated

It’s hard to overstate the complexity of the rules for inherited retirement accounts. To prevent a legal or financial predicament, it is imperative that an account beneficiary get reliable information from a qualified professional who is familiar with IRS regulations.

Other retirement articles that may interest you include:

• How Much Do I Need to Save for Retirement?
• What Age Should I Start Saving for Money?
• Retirement: How Much Should I Save Each Month?