Inherited Roth 401k: Rules for Beneficiaries
Receiving a Roth 401(k) as a beneficiary comes with specific obligations. Learn how to navigate the required timelines and tax rules to preserve its value.
An inherited Roth 401(k) is an employer-sponsored retirement account funded with post-tax dollars that passes to a beneficiary after the original owner’s death. Beneficiaries cannot make new contributions and must follow specific rules for withdrawing the funds, which are distinct from those that applied to the original owner.
The process involves identifying your beneficiary type, understanding distribution choices, meeting withdrawal deadlines, and knowing the tax implications. These aspects are governed by federal law, primarily the SECURE Act, and the specific terms of the 401(k) plan document.
Determining Your Beneficiary Status
Your relationship with the deceased account owner determines your beneficiary status, which dictates your options for the inherited funds. The law creates several distinct categories, with the spousal beneficiary category providing the most flexibility. This status applies only to the legal surviving spouse of the account owner.
A special class of non-spouse beneficiaries, known as Eligible Designated Beneficiaries (EDBs), also receives more flexible options than other inheritors. This category was established by the SECURE Act and includes:
- A minor child of the original account owner
- A person who is disabled or chronically ill under specific IRS definitions
- An individual who is not more than 10 years younger than the deceased account owner
- Certain types of trusts established for the benefit of these individuals
A non-spouse designated beneficiary is anyone named on the account who is not a spouse and does not qualify as an EDB. This is a common classification for adult children or grandchildren. Their options for the inherited account are more restrictive than those for spouses or EDBs.
The most restrictive category is the non-designated beneficiary. This group includes entities that are not individuals, such as the deceased’s estate, a charity, or a non-qualifying trust. These beneficiaries face the most stringent and accelerated withdrawal requirements.
Available Distribution and Rollover Choices
Spousal beneficiaries have several choices for managing an inherited Roth 401(k). A spouse can treat the inherited account as their own by rolling the assets directly into their personal Roth IRA or, if their employer’s plan allows, into their own Roth 401(k). This action makes them the new owner, not just a beneficiary.
Alternatively, a spouse can roll the funds into an Inherited Roth IRA. This keeps the assets separate from their own retirement funds and allows them to take distributions as a beneficiary. A third option is to take a lump-sum distribution, withdrawing the entire account balance at once, which forgoes any future tax-free growth.
Non-spouse beneficiaries, including both EDBs and designated beneficiaries, have fewer options. Their most common path is to request a direct rollover of the assets into an Inherited Roth IRA. This account must be properly titled in the name of the deceased for the benefit of the beneficiary, and the transaction should be a trustee-to-trustee transfer to avoid tax complications.
Non-spouse beneficiaries can also take a lump-sum distribution. While some plans may permit leaving funds in the original account, administrators often require the assets to be moved. This makes the Inherited Roth IRA the most common vehicle for managing these funds.
Navigating Withdrawal Deadlines
For most non-spouse designated beneficiaries, the 10-year rule is the default. This rule, established by the SECURE Act for account owners who died after 2019, mandates that the entire account balance must be distributed by December 31st of the 10th year following the owner’s death. If the original owner died after beginning their own required minimum distributions (RMDs), the beneficiary must also take annual distributions throughout the 10-year period.
Eligible Designated Beneficiaries (EDBs) have a more flexible timeline and can opt to take distributions over their own single life expectancy, a method often called the “stretch.” This allows them to take smaller, annual RMDs based on IRS life expectancy tables. A special provision applies to minor children of the account owner; they can use the life expectancy method until they reach age 21, at which point the 10-year rule begins.
Spousal beneficiaries have unique timing options. If a spouse rolls the inherited Roth 401(k) into their own Roth IRA, they are not required to take any distributions during their lifetime. If they instead open an Inherited Roth IRA, they can choose to either follow the 10-year rule or take distributions based on their own life expectancy.
Failing to empty the account within the required 10-year window results in a penalty. The IRS imposes a 25% penalty on the amount that should have been withdrawn. This can be reduced to 10% if the beneficiary corrects the mistake in a timely manner.
Tax Rules for Beneficiaries
A “qualified” distribution from an inherited Roth 401(k) is received free of federal income tax. For a distribution of earnings to be qualified, the original Roth 401(k) must satisfy the 5-year rule, meaning it was established at least five years prior. The clock for this rule starts on January 1 of the year the original account owner made their first contribution.
This 5-year holding period carries over to the beneficiary. If the original owner satisfied the rule before their death, all distributions of earnings the beneficiary receives are tax-free.
If the original owner had not yet met the 5-year mark, the beneficiary must continue to wait until the five years have passed. Any earnings withdrawn before the 5-year clock is satisfied will be subject to ordinary income tax.