Can I Transfer My 401k to My Child?

Directly transferring a 401(k) account to a child during the account holder’s lifetime is not feasible. Such a transfer would trigger significant tax implications, as it would be considered an early distribution from a retirement account. 401(k) plans are designed as retirement savings vehicles for the account holder and do not permit outright transfer of funds to another individual during their lifetime. A child primarily receives 401(k) assets through inheritance after the account holder’s death.

Designating a Beneficiary for Your 401(k)

Naming beneficiaries for your 401(k) plan ensures your assets pass to your intended heirs. This designation supersedes any instructions in a will, making it the controlling document for your 401(k) assets upon your death. To name a child as a beneficiary, obtain the beneficiary designation form from your 401(k) plan administrator.

Completing this form requires details about your child, such as their full legal name, date of birth, and Social Security number. These details ensure correct identification and facilitate distribution. You should designate both primary and contingent beneficiaries. A primary beneficiary is the first person to receive assets, while a contingent beneficiary is a backup, inheriting funds if the primary beneficiary predeceases you or cannot be located.

For minor children, consider naming a trust as the beneficiary. This allows for structured management and distribution of funds until the child reaches adulthood. Review and update your beneficiary designations regularly, especially after life events like births, deaths, or changes in family circumstances. This ensures your wishes remain accurately reflected and prevents complications for your heirs.

Understanding Inherited 401(k) Distribution Rules

Rules for inherited 401(k) distributions changed with the SECURE Act. For most non-spouse beneficiaries, including children, who inherit a 401(k) from an account holder who died on or after January 1, 2020, traditional “stretch” provisions were eliminated. These beneficiaries are subject to the “10-year rule.”

Under the 10-year rule, the inherited 401(k) account must be fully distributed by the end of the calendar year containing the 10th anniversary of the original account holder’s death. Funds do not have to be withdrawn annually, but the entire balance must be depleted within that decade. If the original account owner died before their required beginning date for distributions, the beneficiary is not mandated to take annual Required Minimum Distributions (RMDs) within this 10-year period.

If the original account owner had already begun taking RMDs, the beneficiary must continue to take RMDs in years one through nine, with the entire balance distributed by the end of the 10th year. Beneficiaries can transfer inherited 401(k) funds into an inherited IRA through a direct trustee-to-trustee transfer. This offers flexibility in managing assets, though the 10-year distribution rule still applies to the inherited IRA.

Taxation of Inherited 401(k) Funds

Distributions from a traditional inherited 401(k) are subject to ordinary income tax for the child beneficiary. Money withdrawn from the inherited account is added to the child’s taxable income in the year it is received. The tax rate applied will be the child’s individual income tax rate, not the original account holder’s. Taking a large lump-sum distribution can push the beneficiary into a higher tax bracket, increasing their overall tax burden for that year.

An advantage for beneficiaries of inherited retirement accounts is the waiver of the 10% early withdrawal penalty. Unlike withdrawals from a personal 401(k) before age 59½, distributions from an inherited account are not subject to this penalty, regardless of the child’s age. This allows beneficiaries to access funds without incurring an additional penalty, though income tax still applies.

For inherited Roth 401(k)s, the tax treatment is more favorable. Qualified distributions from an inherited Roth account are tax-free for the child beneficiary. A distribution is qualified if the account has been open for at least five years and the distribution occurs after the death of the original owner. While federal tax rules are consistent, inherited retirement distributions may also be subject to varying state income taxes.

Specific Scenarios for Inherited 401(k)s

When a minor child inherits a 401(k), they are considered an “eligible designated beneficiary” (EDB), with modified distribution rules. While most non-spouse beneficiaries are immediately subject to the 10-year rule, a minor child of the account owner can initially stretch distributions until they reach age 21, as clarified by the IRS. Once the child reaches age 21, the standard 10-year rule begins, requiring full distribution by the 10th anniversary of their 21st birthday. Distributions for a minor often require a custodial account (UGMA or UTMA) or a trust to manage funds on their behalf.

Children who are disabled or chronically ill at the time of the account holder’s death also qualify as eligible designated beneficiaries and are exempt from the standard 10-year rule. These beneficiaries can stretch distributions over their own life expectancy, providing an extended period for tax-deferred growth. The IRS defines “disabled” as inability to engage in substantial gainful activity due to a physical or mental condition, or “chronically ill” as a severe, long-lasting health condition.

Naming a trust as a 401(k) beneficiary for a child can be an estate planning tool. Trusts offer control over how and when distributions are made, useful for minor children, those with special needs, or for asset protection. To qualify for favorable distribution rules, the trust must meet IRS requirements to be a “see-through” trust, allowing individual beneficiaries to be treated as directly named. If these requirements are not met, the inherited 401(k) could be subject to more rapid distribution schedules, potentially leading to higher immediate tax liabilities.