What Happens to a 401k Inheritance After One’s Death?

When you think of estate planning, your mind probably jumps straight to wills, trusts, or maybe even a power of attorney. But what happens to your retirement accounts after you are gone is not limited to these tools. While you may decide how your assets are managed after you in your will and set up trusts for other assets, your 401(k) will not adhere to these instructions. This is why understanding what happens to your 401(k) when you die is so crucial.

Some parts of estate planning are entirely up to you. You decide who gets what, how they receive it, and when. But when it comes to tax-advantaged accounts like a 401(k), there are strict rules set by the government about how that money is inherited.

You cannot change these rules. And these rules can affect your family in a big way, both financially and emotionally. For instance, if you have named a beneficiary on your 401(k), that designation will supersede whatever you have written in your will. There are also Internal Revenue Service (IRS) rules about how quickly the money must be withdrawn, and those rules can differ depending on the beneficiary’s relationship to you.

This is why it is essential to plan well now and thoroughly understand the 401(k) beneficiary rules, so you can save your loved ones a lot of stress later. Let’s dig into who gets your 401(k) if you die.

What happens to my 401(k) if I die?

Your 401(k) is simply inherited by the person(s) you nominate on the account. When you open a 401(k), you are given a beneficiary form. You are supposed to mention the name(s) of the individual(s) to whom you want to leave your 401(k) money. This is an essential piece of paperwork and solely decides who gets your hard-earned 401(k) savings, no matter what your will says. In fact, this is why naming and regularly updating your beneficiaries is extremely important.

If your beneficiary designations do not match your current wishes, the wrong person could end up with your retirement savings. And if you never name a beneficiary, things can get complicated. Your 401(k) will likely end up in your estate, which would result in your family most likely having to go through probate court. Probate can be time-consuming, costly, and in most cases, can create unnecessary stress for your family.

Now, say you have been thorough and named a beneficiary on your 401(k) account. Let’s move on to how these beneficiaries inherit your account.

1. The spouse usually inherits the 401(k)

Federal law usually gives your spouse the first right to inherit your 401(k), unless you name someone else. For instance, if you die and your spouse is alive, they would automatically inherit your account. However, if you wish to nominate someone else, you can do so. But it is important to note that if you want the money to go to anyone other than your spouse, you generally need their written consent.

401(k) beneficiary rules for a surviving spouse are pretty relaxed. Once your spouse inherits your 401(k), they have several options. They can roll it into their own retirement account. This will ensure the funds within the account continue to grow and enjoy a tax-deferred status.

Alternatively, your spouse can also leave the 401(k) as an inherited account and take withdrawals as needed. Either way, they keep the tax advantages of the account, which can make a big difference over time. They can also take withdrawals before age 59½ without paying an early withdrawal penalty, though they would still have to pay income taxes at prevailing rates.

2. The children, siblings, or others inherit the 401(k)

Anyone other than your spouse is categorized as a non-spousal beneficiary. These can be your children, siblings, friends, etc. These individuals can inherit the account, but they cannot roll the inherited 401(k) account into their own 401(k).

However, they can move the funds into an inherited Individual Retirement Account (IRA) and then follow the 10-year rule. This rule requires them to empty the account within ten years of your death. The critical thing to note here is that these withdrawals are taxable. So, the inheritors may likely be pushed into a higher tax bracket. The 10-year rule is mandatory for all non-spousal beneficiaries under the Setting Every Community Up for Retirement Enhancement (SECURE) Act.

You can name minor children as beneficiaries of your 401(k), but there are a few extra steps to keep in mind. Firstly, they will not be able to access the money right away. Minors cannot legally control inherited 401(k) funds until they reach adulthood. Until then, a guardian or trustee will need to manage the account on their behalf. Now, it is your responsibility to name a guardian or trustee. If you fail to do so, the court will appoint one. But similar to the probate process, this can also take time. Moreover, the person the court appoints may not be the person you would have chosen to handle the money. So, it is better to set these things up yourself.

3. Multiple inheritors are named on the account

If you have multiple beneficiaries listed, such as your spouse and two children, the money will be split between all of them. But you get to decide who receives how much. You can specify exactly what percentage of the account each of your dependents receives. Say, you can nominate your spouse to receive 60% and your children 20% each.

4. A charity or organization inherits the 401(k)

You can also leave your 401(k) or a portion of it to a charity or nonprofit organization. Doing this is pretty straightforward. You simply list the organization as a beneficiary on your designation form. And if you are splitting your 401(k) between multiple charities or even between a charity and family members, you can specify the percentage each one should receive. Charitable organizations do not pay income tax on the money like other beneficiaries, so the full amount goes toward the cause you care about.

If you die, what happens to your 401(k) in case of no beneficiaries?

This is a mistake more common than you would think. This usually happens to people who are single and do not have children. But if you never get around to filling out the paperwork, it can create a lot of problems for the people you leave behind.

When no beneficiary is listed, your 401(k) does not automatically pass to your closest relative. Instead, it usually becomes part of your estate and gets tied up in probate court. Probate can be long, expensive, and stressful for your family. Your 401(k) money could be sitting there for months.

On top of that, once your 401(k) becomes part of your estate, you lose some of the tax advantages that generally come with inherited retirement accounts. Your heirs may have to bear the brunt of estate taxes. If you are not married, the situation can get even more complicated. State laws will decide who gets your money, which might not align with what you intended. Without a beneficiary, the law makes that choice for you.

Therefore, you must always name a beneficiary, even if you are single or unsure. And, you can always update it later if your situation changes.

What if the people you named as beneficiaries pass away before you do?

When you fill out your 401(k) beneficiary form, you are usually asked to name both primary and contingent beneficiaries. Your primary beneficiaries will receive the money when you pass away. But if they are not around, your contingent beneficiaries act as backups. They inherit your 401(k) if your primary beneficiaries cannot. For example, say you named your spouse as your primary beneficiary and your two children as contingents. If your spouse passes away before you, your 401(k) would go directly to your kids. There would be no probate.

But if you never named contingent beneficiaries and your primary beneficiary is no longer living, your 401(k) usually becomes part of your estate. It will then suffer the fate of probate court. This can delay payouts and increase legal costs, all things you must definitely aim to avoid. Adding contingent beneficiaries can ease all of this. You can name them on the beneficiary form and update them anytime.

What happens if your beneficiary refuses to accept the 401(k)?

Believe it or not, but this can happen. Money matters can be driven by emotions more often than not. And for whatever reason, your beneficiary can refuse to accept the 401(k) as an inheritance. If they choose to do so, the assets typically pass on to the next person listed as a contingent beneficiary. This is another reason to make sure your account has a contingent beneficiary.

However, if there are no contingent beneficiaries or if they also refuse to accept the inheritance, the 401(k) will usually end up as part of your estate and go through probate along with everything else you own.

Things to do as an account owner to ensure your loved ones are not affected in your absence

You can never be too prepared for the future, especially for the plans that will matter when you are no longer here. Here are some things you can do:

1. Keep your beneficiary designations updated

Your beneficiary form is a powerful document. It decides who gets your money when you are gone. That is why it is critical to check your beneficiary designations regularly. The easiest way to do this is to contact your plan provider, usually through your employer’s Human Resources (HR) department or directly with the financial institution that manages your 401(k). Make sure you have both a primary and a contingent beneficiary listed. A contingent beneficiary can be your backup if your primary beneficiary passes away before you do.

Also, do not stop at just filling out the beneficiary once and forgetting about it. You need to review it after every major life event. So, if you get married, divorced, widowed, or have children, your 401(k) plan should be updated accordingly.

2. Align your will and beneficiary forms

Even though beneficiary forms predominate what your will says, it is still a good idea to make sure everything matches up. When the beneficiary names or percentages differ between your will and your beneficiary forms, it can create confusion or even conflict among family members. Matching them helps keep things smooth and avoids unnecessary disputes.

3. Understand the prevailing tax rules

Another crucial step is understanding the tax implications of inheriting a 401(k). The rules differ for spouses and non-spouses, and they have changed in recent years due to laws like the SECURE Act. You must learn what applies to your specific situation and talk to a financial advisor, if needed. Then, you must share this knowledge with your beneficiaries so they know what to expect when the time comes.

4. Prepare your loved ones

Your beneficiaries will be the ones to actually start the process of claiming your 401(k). The plan administrator will guide them, but they will need to provide documents, such as a death certificate, to initiate the transfer. Have a conversation with them now. Let them know where your account information is, who to contact, and what they need to do. This can prevent confusion and delays during an already stressful time.

5. Work with a financial advisor

Finally, consider meeting with a financial advisor or estate planning professional. They can help you coordinate your beneficiary forms with your overall estate plan. They can also keep you informed of rule changes and make sure you make the right estate planning decisions.

Parting thoughts

A 401(k) account comes with a long list of rules. These rules govern everything from how you contribute to when you withdraw, to how your money is passed on after you are gone. Understanding these rules can help you protect your family’s future. So, keep your beneficiary forms up to date, talk to your loved ones about what they will need to do, and stay informed about the tax rules that apply to them.

If you need help making sense of the 401(k) beneficiary rules, talk to a good financial advisor and understand the details. If you do not already have one, tools like the free advisor match tool can help you get matched with 2 to 3 vetted financial advisors who fit your needs.