What happens when you inherit a 401k from a parent?
Inheriting a 401k from a parent is a significant financial event that raises several questions. As the beneficiary, there are specific rules and options that you should be aware of before making any decisions. This article will address the question of what happens when you inherit a 401k from a parent and provide answers to common related FAQs.
When you inherit a 401k from a parent, the first thing to determine is whether the account is a traditional or a Roth 401k. The treatment and taxation of inherited funds differ based on this distinction. Regardless of the type, the inherited 401k will become an inherited IRA (Individual Retirement Account) that you will need to manage going forward.
With an inherited traditional 401k, you have the option to take a lump sum distribution, which requires you to pay taxes on the entire amount as ordinary income in the year you receive it. Alternatively, you can set up a beneficiary distribution account (also known as an inherited IRA) and take required minimum distributions (RMDs) based on your life expectancy. The advantage of this option is that the remaining funds in the account continue to grow tax-deferred.
On the other hand, if you inherit a Roth 401k, the funds can be withdrawn completely tax-free if the account was held for at least five years prior to your parent’s passing. Otherwise, you may still avoid penalties but have to pay taxes on the earnings. Similar to an inherited traditional 401k, you have the option to set up an inherited Roth IRA and take distributions based on your life expectancy, allowing the remaining funds to continue growing tax-free.
Frequently Asked Questions:
1. Can I leave the inherited 401k account as it is?
No, when you inherit a 401k, you must take action and designate it as an inherited IRA or distribute the funds.
2. How are taxes calculated for an inherited 401k?
The taxation of an inherited 401k depends on whether it is a traditional or Roth account and how you choose to take distributions.
3. Can I roll over an inherited 401k into my own retirement account?
No, as a non-spouse beneficiary, you cannot directly roll over an inherited 401k into your own retirement account. You must open an inherited IRA.
4. What are the penalties for not taking the required minimum distributions (RMDs)?
If you fail to take the RMDs, you may be subjected to a 50% penalty on the amount that should have been withdrawn.
5. What is the deadline for taking my first required minimum distribution?
You are usually required to withdraw your first RMD by December 31st of the year following your parent’s passing.
6. Can I withdraw more than the required minimum distribution (RMD) amount?
Yes, you can always withdraw more than the RMD amount, but keep in mind the tax implications of doing so.
7. Can I name my own beneficiaries for the inherited 401k?
No, you cannot name new beneficiaries for an inherited 401k. Instead, the remaining funds will be distributed according to the original account holder’s designated beneficiaries.
8. Can I combine an inherited traditional 401k with my own traditional IRA?
No, you cannot combine an inherited 401k with your own traditional IRA. They must be kept separate.
9. Are there any limitations on who can inherit a 401k?
Typically, a 401k can be inherited by any designated beneficiary named by the account holder, such as a child or a spouse.
10. Can I convert an inherited traditional 401k to a Roth IRA?
Yes, you can convert an inherited traditional 401k to a Roth IRA, but you must pay taxes on the converted amount.
11. What happens if I inherit a 401k and I am already retired?
If you have already reached the age of 72, you will still need to take the RMDs from the inherited account each year.
12. Can I stretch the distributions from an inherited 401k over my lifetime?
No, as a non-spouse beneficiary, you are generally required to take distributions based on your life expectancy. However, keep in mind the unique distribution rules for inheriting from a parent.