How is inherited 401k taxed

A lump-sum distribution is where you withdraw all the money from your inherited k at once. This is simple and gives you a large influx of cash, but you must pay taxes on those funds all in a single year. That usually means you end up losing more of your inheritance back to the government than you would have if you'd used one of the other distribution strategies listed here.

The five- and year rules enable you to take money out whenever you need it as long as everything is withdrawn from the inherited k by the end of the fifth or 10th year, respectively, following the account owner's death. The five-year rule applies if the account owner died in or earlier, and the year rule applies if they died in or later. This strategy gives you more flexibility in terms of when you withdraw your money, and it can help you spread the tax liability over a few years.

If you're not the account owner's spouse, the year rule is probably your best bet since the federal government tightened restrictions on the life expectancy method discussed below for account owners who died in or later.

But if the account owner died before , you may prefer the life expectancy method to the five-year rule if you want the most out of your inheritance. The five-year rule may not even be an option for you if the account owner was already taking required minimum distributions RMDs before they died. The life expectancy method requires you to take RMDs from the account based on your life expectancy, which you calculate by dividing the total value of the inherited k by the distribution period next to your age in the IRS Single Life Expectancy Table.

For every subsequent year, you subtract one from the distribution period and divide the remaining balance by this new number. This strategy is popular because it enables you to spread your money out over decades and possibly end up with a lot more than you otherwise would have. It also minimizes the effect the inherited k funds have on your taxes in a given year. You're always free to take out more money than the RMD if you need to, but you don't have to.

Anyone can use this strategy if the account owner died prior to , but for account owners who die in or later, only the following individuals can use the life expectancy method:. Table of Contents Expand. Inherited IRA Basics. Inherited k Rules. Required Minimum Distributions. Creditor Protection. Commingling Accounts. The Bottom Line. Key Takeaways Spousal beneficiaries of an IRA have the option of taking the account and managing it as if it were their own, including the calculation of required minimum distributions RMDs.

Non-spousal beneficiaries have to take distributions from the total account within 10 years of the death of the original account holder.

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Related Articles. Estate Planning Sept. Partner Links. An Extended IRA allowed a second-generation beneficiary to withdraw assets at a rate based on the life expectancy of the first-generation beneficiary. Understanding Death Benefits A death benefit is a payout to the beneficiary of a life insurance policy, annuity or pension when the insured or annuitant dies.

The tax rules are quite complicated. If the k holder had not already set up a payment schedule before he or she died, you may still be able to set up your own payment schedule, either over five years or over your life expectancy, if the plan allows it. If this is an option, you normally have until December 31 of the year after the person dies to decide whether you prefer the five-year option or the life-expectancy option. If you don't specify a choice by then, the life expectancy will automatically be used for a spouse, and the five-year method will automatically be used for a non-spouse.

Under this option, if you are the spouse you have another decision to make. If you are NOT the spouse, you will have to start receiving the payments by the end of the year following the person's death.

In other words, you don't have the same possibilities as the spouse for postponing receipt of the taxable income. Conclusion As you can see, there are tax implications no matter what strategy you choose for receiving the k funds you inherit. Therefore, you should strongly consider consulting a tax professional who can help you determine what options you have for receiving the money, and the income tax consequences of the different options.

This isn't the kind of calculation you want to do yourself on the back of an envelope. If you inherit a k from your spouse, what you decide to do with it and the subsequent tax impacts may depend largely on your age. Again, there would be no early withdrawal penalty but you would pay income tax on the withdrawals. You can make withdrawals without triggering an early withdrawal penalty.

This kind of account would require you to take minimum distributions but the amount would be based on your own life expectancy, not the amount your spouse would have been required to take.