Quick Summary: Inheriting IRAs and 401(k)s
When a retirement account owner passes away, the funds are distributed based on beneficiary designations. If a beneficiary is named, the account bypasses probate and can be claimed by presenting a death certificate. However, if no beneficiary was named, the account becomes part of the probate estate and is distributed according to state law or a will. Surviving spouses have the most flexibility, including rolling the funds into their own IRA to continue tax deferral.
Key Options for Heirs:
- Spousal Rollover: Spouses can move the funds into their own account to delay Required Minimum Distributions (RMDs).
- Inherited IRA: Non-spouse beneficiaries must typically move funds into an Inherited IRA and follow specific withdrawal timelines.
- Probate Assets: Without a named beneficiary, the account must go through the court-supervised probate process.
- Tax Implications: Most distributions from traditional IRAs or 401(k)s are taxed as ordinary income to the beneficiary.
Retirement accounts generally fall into two categories: employer-sponsored plans (like 401(k)s) and individual plans (IRAs). While these accounts are designed for your later years, understanding what happens to them after death is a crucial part of estate management.
The distribution of these accounts depends primarily on whether the owner designated a beneficiary. If a person or entity was named, the account is “non-probate,” meaning it transfers directly to the heir. If no beneficiary exists, the account is paid into the estate, where it must wait for the probate court to authorize distribution.
Options for Surviving Spouses
Surviving spouses have unique legal protections and choices regarding inherited retirement funds:
- Rollover: You can roll the assets into your own IRA. This allows you to continue deferring taxes and use your own life expectancy for required distributions.
- Leave it as is: You can treat the account as the deceased’s. This is often beneficial if you are under 59½, as it may allow you to avoid certain early withdrawal penalties.
- Trust Transfer: If an A or B Trust was established in the estate plan, the funds can be moved there, maintaining tax-deferred status.
Options for Non-Spouse Beneficiaries
If you are a child, relative, or friend named as a beneficiary, your options are more restricted:
- Lump Sum: You can cash out the account immediately, but you will owe income taxes on the entire distribution.
- 5-Year Rule: In some cases, you can spread withdrawals over five years if the owner died before age 72 (formerly 70½).
- Inherited IRA: You can move the funds into an account specifically labeled as an “Inherited IRA.” You must typically begin taking distributions by December 31 of the year following the owner’s death.
Why Probate Matters
If the retirement accounts were left to the “estate” rather than a person, they become tied up in the probate process. This can delay your access to the funds by 12 to 24 months. If you find yourself in this situation and need immediate liquidity, an inheritance advance can provide you with cash now, using the eventual estate distribution as the basis for the advance.
Disclaimer: IRS regulations on inherited accounts are complex. Always consult a qualified tax professional or financial advisor before making a decision.
Frequently Asked Questions
A 401(k) only goes through probate if there is no valid beneficiary designation on file with the plan administrator. If a beneficiary is named, the funds transfer directly to that person, bypassing the court process entirely.
Yes, distributions from traditional IRAs and 401(k)s are generally taxed as ordinary income. However, inherited Roth IRAs are typically tax-free, provided the account was open for at least five years before the owner’s death.