• Skip to main content
  • Skip to primary sidebar

Legal Consumer BLOG

Empowering Consumers Since 2006

Home » Inheritance Law » What to Do When You Inherit an IRA or 401k

What to Do When You Inherit an IRA or 401k

November 20, 2019 by Liza Hanks

Inherited IRA written on a piggy bank | Inherit an IRA or 401k

Have you inher­ited an IRA or 401k plan? Estate plan­ning expert Liza Hanks tells you what rules apply and what to do next.

Inher­it­ing money is not some­thing most of us do more than once or twice in a life­time, if ever. For the vast major­ity of us, this money comes to us free of estate tax, because cur­rent law taxes only estates worth more than $10 mil­lion, indexed each year for inflation.

But money that you inherit from an IRA or 401k is dif­fer­ent, because you’ll pay taxes on money you with­draw. For many of us, that’s the main tax con­se­quence of inher­it­ing at all.

How Tra­di­tional IRAs and 401ks Work

In a tra­di­tional IRA or 401k, a per­son saves money dur­ing their work­ing lives, where it grows free of tax. At the age of 70 ½, they have to start tak­ing out that money and pay­ing tax on those with­drawals. (These with­drawals are called min­i­mum required dis­tri­b­u­tions, or RMDs.) The idea is that they saved that money while work­ing (and pay­ing a higher income tax rate on those earn­ings) but can with­draw that money when they’ve retired (and are pre­sum­ably now at a lower income tax bracket).

If there’s money left in an IRA or 401k when the per­son dies, the named ben­e­fi­ciary inher­its the account.  Wills and trusts don’t gov­ern the dis­tri­b­u­tion of retire­ment accounts; they go to the ben­e­fi­ciary named on the plan’s paper­work. If the account holder does­n’t name any­one, the account usu­ally passes to their estate when they die, per­haps trig­ger­ing a pro­bate pro­ceed­ing. (Nam­ing a ben­e­fi­ciary for a retire­ment account is one of the eas­i­est ways to avoid pro­bate.)

Rules for Inher­it­ing an IRA or 401k

There are two sets of rules for inher­it­ing retire­ment assets: one for sur­viv­ing spouses and one for every­one else. These rules are com­pli­cated and can feel bewil­der­ing. But when you inherit a retire­ment plan, the plan’s admin­is­tra­tor will guide you through your choices. For the pur­poses of this arti­cle, the eas­i­est way to explain the rules is to look at an example.

Let’s say your Uncle Joseph died at 62, so hadn’t begun tak­ing money out of his IRA. If Joseph named his wife, Sonia, as the ben­e­fi­ciary of his IRA, she will be able to roll that inher­ited IRA into her own indi­vid­ual IRA. Then she won’t have to start tak­ing money out until she is 70 ½.  Sonia could also choose to keep the money in Joseph’s account, but most peo­ple do the rollover unless they have an imme­di­ate need for the money. Until Sonia reaches 70 1/​2, her IRA, includ­ing the inher­ited money, can con­tinue to grow free of tax. She can also con­tinue to make con­tri­bu­tions to it. (If Joseph had died after he turned 70 ½, these rules would be slightly different.)

But if Uncle Joseph left you, his beloved niece or nephew, his IRA, you’ll face a dif­fer­ent set of rules. First, you can’t add any more money to that account. Sec­ond, you have to with­draw the money start­ing the year after Joseph died. And the money you with­draw is sub­ject to income tax at your indi­vid­ual rate. If you don’t take these required dis­tri­b­u­tions, the IRS imposes a fifty per­cent tax penalty on the amount you don’t withdraw.

How to With­draw Money From an Inher­ited IRA

Con­tin­u­ing the exam­ple above, cur­rent law gives you three choices for with­draw­ing money from an Inher­ited IRA:

  1. You can take all the money out and pay tax on the withdrawal.
  2. If Uncle Joseph hadn’t started tak­ing out RMD’s, you can leave the money in the account for up to five years.
  3. You can take out a small amount each year, based on your life expectancy, defined by the IRS in spe­cial tables.

That last option is called “stretch-​out” plan­ning because it allows you to extend your with­drawals over your entire life­time. (There’s a new law, called the Secure Act, that has passed the House, that would limit the stretch-​out to ten years, but the Sen­ate has­n’t yet voted on it.) Most finan­cial plan­ners rec­om­mend doing stretch-​out plan­ning because:

  • the account con­tin­ues to grow tax free, and
  • smaller, annual with­drawals will have a less dras­tic effect on your income taxes each year.

But if you want to take more money out in a given year, you can do that as well. An Inher­ited IRA only has a min­i­mum required dis­tri­b­u­tion, there’s no max­i­mum distribution.

Return­ing to our exam­ple: If you’ve inher­ited an IRA worth $100,000 from Uncle Joseph, and you are 43 years old, the IRS tables say you have a life expectancy of 43.6 more years. Divid­ing $100,000 by 43.6 you get $2,294, so that’s how much you’d be required to with­draw from the account at the end of the year. Each year after that, you’d sub­tract one year from the life expectancy used the pre­vi­ous year to cal­cu­late your RMD, so next year you’d use 42.6. But, actu­ally, the plan admin­is­tra­tor will tell you what the RMD is, you don’t have to cal­cu­late that your­self. If you need to take more money out, you can do so, but you’ll be taxed on that with­drawal. And if you take out a big chunk of cash, it could push you into a higher tax bracket, too.

With­draw­ing Money From Inher­ited 401k Plans and Roth IRAs

Inher­it­ing assets from a 401k is sim­i­lar to what I’ve out­lined above. If you are a spouse, you can roll the 401k over into your IRA. If you are not the spouse, you can con­vert the 401k into an Inher­ited IRA. Some 401k plans allow the deceased person’s assets to stay in the plan as an inher­ited account and include stretch-​out pro­vi­sions, but many do not. When no stretch-​out plan­ning is avail­able, you would either have to with­draw the entire account within five years from that 401k, or con­vert that account into an Inher­ited IRA.

Roth IRAs and Roth 401ks are dif­fer­ent. Gen­er­ally speak­ing, if you are a spouse, you can delay dis­tri­b­u­tions until the time when the deceased IRA owner would have been 70 ½ or treat the Roth IRA as your own. If you are not the spouse, you must with­draw the assets in that inher­ited Roth IRA within five years.  But, because these are Roth plans, these assets are not sub­ject to tax upon with­drawal, as long as the Roth has been open five years or more.

More Infor­ma­tion

For the lat­est infor­ma­tion on estate taxes and other inher­i­tance laws, see What’s New for 2019 for Fed­eral and State Estate, Inher­i­tance, and Gift Tax Law. To learn more about your state’s rules, see Does Your State Col­lect an Inher­i­tance Tax? in Legal Con­sumer’s Inher­i­tance Law learn­ing cen­ter.

For more about pro­bate and how to avoid it, see What Is Pro­bate and How Does It Work?

Liza Han­ks’s most recent book is Every Cal­i­for­ni­an’s Guide to Estate Plan­ning. To con­nect with her directly, visit www​.liza​hanks​.com. A ver­sion of this arti­cle orig­i­nally appeared on her blog.

Filed Under: Inheritance Law Tagged With: estate tax, inheritance tax, IRA, probate

About Liza Hanks

Liza Hanks is a partner at GCA Law Partners LLP in Mountain View, California, where she practices estate planning, trust administration, and probate law. She’s the author of Every Californian’s Guide to Estate Planning: Wills, Trusts & Everything Else and The Trustee’s Legal Companion (with Attorney Carol Zolla) and she writes about estate planning and inheritance law here at Legal Consumer. Liza is a graduate of Stanford Law School, a former magazine editor, and the mother of two children (neither of whom show any desire to become attorneys).

Primary Sidebar

Legal info by zip code (legal​con​sumer​.com)

  • Bank­ruptcy law
  • Unem­ploy­ment law
  • Wage and hours law
  • ACA/​Obamacare law
  • Health­care law
  • Child cus­tody law
  • Inher­i­tance law
  • Stu­dent loan law
  • Democ­racy law

More Blog Articles

  • Bank­ruptcy
  • Democ­racy
  • Child Cus­tody
  • Inher­i­tance Law
  • Oba­macare, ACA
  • Over­time, Min­i­mum Wage Law
  • Unem­ploy­ment Benefits

Deprecated: Hook genesis_footer_creds_text is deprecated since version 3.1.0! Use genesis_pre_get_option_footer_text instead. This filter is no longer supported. You can now modify your footer text using the Theme Settings. in /var/www/blog/www/wp-includes/functions.php on line 5758

© 2023 | Relational Vision LLC, dba LegalConsumer.com | Disclaimer: Legal information is not legal advice
Self-help services may not be permitted in all states. The information provided on this site is not legal advice, does not constitute a lawyer referral service, and no attorney-client or confidential relationship is or will be formed by use of the site. The sponsored attorney advertisements on this site are paid attorney advertising. In some states, the information on this website may be considered a lawyer referral service. Your use of this website constitutes acceptance of the Terms of Use, Privacy Policy and Cookie Policy.