Inherited 401k From Spouse: Rules and Options

Inheriting a 401(k) from a spouse requires navigating a series of financial decisions. The rules governing these assets are unique for surviving spouses, offering a degree of flexibility not available to other beneficiaries. This article provides an explanation of the choices, tax implications, and procedural steps for a surviving spouse managing an inherited 401(k).

Distribution Choices for a Surviving Spouse

When a spouse inherits a 401(k), they have several distinct paths for the funds, each with its own rules and financial consequences.

Spousal Rollover to an IRA

The most frequent option is to directly roll over the inherited 401(k) assets into a new or existing Individual Retirement Arrangement (IRA) in the surviving spouse’s name. This is a non-taxable event that consolidates the retirement funds under the survivor’s control. By moving the money into a personal IRA, the assets can continue to grow tax-deferred, and the surviving spouse can name their own beneficiaries for the account.

Once the funds are in the spouse’s IRA, they are subject to the same rules as any other IRA. Required minimum distributions (RMDs) will be based on the surviving spouse’s age, not the deceased’s. The primary drawback is that once the funds are in the spouse’s own IRA, any withdrawals made before the surviving spouse reaches age 59.5 will be subject to a 10% early withdrawal penalty.

Treating the 401(k) as Your Own

Some 401(k) plans may permit a surviving spouse to treat the inherited 401(k) as their own account. This option is entirely dependent on the specific rules of the deceased’s 401(k) plan document. If available, it can be a straightforward way to manage the assets without needing to open a new account. The benefit of this approach is maintaining the high level of creditor protection afforded to 401(k) plans under the Employee Retirement Income Security Act (ERISA). The RMD rules would be based on the surviving spouse’s age, but this option may come with fewer investment choices.

Remaining a Beneficiary of the 401(k)

A surviving spouse can choose to leave the funds in the deceased’s 401(k) and be treated as the account beneficiary. In this scenario, the account is retitled to show it is an inherited account. The main advantage of this choice is the ability to take distributions from the account without incurring the 10% early withdrawal penalty, even if the surviving spouse is under age 59.5. This makes it a useful option for a younger spouse who may need to access the funds before reaching retirement age.

Lump-Sum Distribution

The final option is to take a lump-sum distribution, which means cashing out the entire 401(k) balance at once. While this provides immediate access to the full amount, it is often the least favorable choice from a tax standpoint. The entire distribution is considered taxable income in the year it is received, which can push the surviving spouse into a higher tax bracket. The 401(k) plan is required to withhold a mandatory 20% for federal taxes on a lump-sum payment, but the final tax liability could be much higher.

Navigating Required Minimum Distributions (RMDs)

Required Minimum Distributions, or RMDs, are amounts that the federal government requires you to withdraw annually from most retirement accounts after you reach a certain age. The rules for RMDs on an inherited 401(k) are specific and change based on the distribution choice the surviving spouse makes. These rules are designed to ensure that tax-deferred retirement funds are eventually paid out and taxed.

If You Rolled Over to Your Own IRA

When a surviving spouse rolls the inherited 401(k) into their own IRA, the RMD rules are based entirely on the survivor’s age. The RMD status of the deceased spouse no longer has any bearing on the account. The funds are treated as if the surviving spouse had contributed them, meaning RMDs are not required until the survivor reaches the current RMD age. Under the SECURE 2.0 Act, the RMD age is 73 for individuals born between 1951 and 1959, and it is set to rise to 75 for those born in 1960 or later.

If You Remain a Beneficiary

Choosing to remain a beneficiary of the deceased’s 401(k) results in a more complex set of RMD rules. The requirements depend on whether the deceased spouse had already started taking their own RMDs.

Scenario A: Deceased Spouse Was Younger Than RMD Age

If the deceased spouse passed away before reaching their RMD beginning age, the surviving spouse has a choice. They can delay the start of RMDs until the year the deceased spouse would have reached RMD age. Once that year arrives, the surviving spouse must begin taking distributions calculated based on their own single life expectancy, which is recalculated each year. This delay allows the account to continue growing tax-deferred for a longer period.

Scenario B: Deceased Spouse Was Already Taking RMDs

If the deceased spouse had already begun taking RMDs, the surviving spouse must continue receiving distributions, starting by December 31 of the year after the death. The surviving spouse has flexible options for calculating the amount. They can use the Single Life Expectancy Table based on their own age or elect to be treated as the deceased, which allows them to use the Uniform Lifetime Table. This second option often results in a smaller RMD, preserving more of the assets in the account.

Tax Treatment of Inherited Funds

The tax implications of an inherited 401(k) are directly tied to the distribution method chosen by the surviving spouse.

Tax on Rollovers

A direct rollover from the inherited 401(k) to a spousal IRA is a non-taxable event. No income tax is due at the time of the transfer. The funds maintain their tax-deferred status inside the new IRA, and taxes are only owed when the surviving spouse begins taking distributions from that IRA in the future. This deferral allows the entire pre-tax amount to be invested and continue growing.

Tax on Distributions

Any money withdrawn from the 401(k) is taxed as ordinary income in the year it is received. This applies whether the spouse takes a partial withdrawal as a beneficiary or takes a full lump-sum distribution. The amount withdrawn is added to the spouse’s other income for the year, such as salary or Social Security benefits, and taxed at their marginal tax rate.

Lump-Sum Withholding

If a surviving spouse elects to take a lump-sum distribution, the 401(k) plan administrator is required by federal law to withhold 20% of the total amount for taxes. This is a prepayment, not a final tax payment. The actual tax liability will be calculated on the spouse’s annual tax return and could be higher or lower than 20%, depending on their total income and tax bracket.

The 10% Early Withdrawal Penalty

A benefit for spouses is the exemption from the 10% early withdrawal penalty. If a surviving spouse is under age 59.5 and takes a distribution while remaining a beneficiary of the 401(k), this penalty does not apply. This protection is lost if the spouse rolls the funds into their own IRA. Once in the survivor’s own IRA, any withdrawals before they reach age 59.5 would be subject to the 10% penalty, unless another exception applies.

Inheriting a Roth 401(k)

If the inherited account is a Roth 401(k), the tax treatment is more favorable. For a withdrawal of earnings to be tax-free, a five-year holding period must be met. This five-year clock begins when the deceased spouse first made a contribution to their Roth 401(k). If the surviving spouse rolls the inherited Roth 401(k) into their own Roth IRA, they can use whichever five-year clock is more favorable—their own or the deceased’s—to meet the requirement for tax-free withdrawals.

Steps to Access and Manage the 401(k)

After deciding on a course of action, the surviving spouse must follow a specific process to claim and manage the inherited 401(k) funds.

Information Gathering and Preparation

Before initiating any action, collect all the required paperwork. A recent account statement for the deceased’s 401(k) will contain the account number and contact information for the plan administrator. The administrator will provide the specific forms needed, often called a “Death Benefit Claim Form.” You will need to provide:

• An original, certified copy of the death certificate
• Proof of your identity, such as a government-issued photo ID
• Your marriage certificate to verify your spousal status
• Information for the new account if you are performing a rollover

The Action Process

With the necessary documents, contact the 401(k) plan administrator to initiate a claim for the account balance. They will guide you on their specific procedures and confirm the documents they require. You will then submit the completed forms along with the certified death certificate and any other requested documents. After the plan administrator reviews and approves the claim, the funds will be transferred to your designated account or a check will be issued. You will also receive a final statement and the necessary tax forms, such as a Form 1099-R, in the following year.