Tax Implications of Inherited 401(k) Accounts

Tax laws for retirement accounts can be very complex. When you start receiving distributions, how much you receive and for how long are important factors. When 401(k) accounts are inherited, the rules are somewhat different. Understanding the tax implications of inherited 401(k) accounts can help you minimize tax burdens.

Payout Options At Death of Account Owner

The terms and options for 401(k) accounts can actually vary. Some require a lump sum payout to beneficiaries while others offer an extended payout option. All payouts are taxed as regular income, so this can have significant tax consequences. Lump sum payouts generally put beneficiaries into a different tax bracket than smaller payouts. When extended payouts are allowed, they generally range from 5 to 10 years. Obviously, with a longer payout period, less money is received by beneficiaries each year and reported as taxable income,…thus tax implications of inherited 401(k) accounts are reduced.

Additional Options for Spouses

Spouses have 2 additional options for inherited 401(k) accounts. The first is the ability to rollover funds and treat it as their own retirement account. The rules of the spouse’s retirement accounts apply and taxes specific to the inheritance are essentially spread out to match the surviving spouse’s own accounts. A second option is sometimes available to leave the funds in the original account until the deceased spouse would have reached full retirement age (72 yrs old). Accounts that allow extended payouts typically offer this second option to spouses.

Summary of Tax Implications of Inherited 401(k) Accounts

Beneficiaries of 401(k) accounts must pay taxes on the inheritance, but they do avoid early withdrawal penalties. These are the most common tax implications of inherited 401(k) accounts, but it’s important to note that a higher taxable income could have other repercussions. Consult with a tax advisor for guidance specific to your circumstances before selecting a payout strategy.