What to Do With an Inherited 401k From a Parent?

Inheriting a 401(k) from a parent means you are now responsible for a significant financial asset. As a non-spouse child, you must follow a specific set of IRS rules that differ from those for a surviving spouse. You will need to understand your beneficiary classification, the timeline for withdrawing the funds, and the options for how to manage the money to preserve its value and avoid tax penalties.

Understanding Your Beneficiary Status

The first step in managing an inherited 401(k) is to determine your beneficiary status under the rules established by the SECURE Act of 2019. For a child inheriting a parent’s account, you will fall into one of two main categories, and this classification dictates the timeline for withdrawing the funds.

Most adult children who inherit a 401(k) are classified as “Designated Beneficiaries.” This is the default category for a non-spouse individual named on the account’s beneficiary form and subjects you to a specific set of distribution rules.

A different set of rules applies if you qualify as an “Eligible Designated Beneficiary” (EDB). This category is reserved for beneficiaries who meet specific criteria. For a child of the deceased, you may qualify as an EDB if you are a minor, are considered disabled, or are chronically ill.

To be considered disabled or chronically ill, you must meet strict IRS definitions, which may require certification from a licensed health care practitioner. For these purposes, a minor child is defined as one who has not yet reached age 21.

Distribution Rules Based on Your Status

The distribution rules for an inherited 401(k) are directly tied to your beneficiary status. These regulations determine when and how much money you must withdraw from the account.

If you are a “Designated Beneficiary,” you are subject to the 10-year rule. This rule requires that the entire balance of the inherited 401(k) be withdrawn by December 31st of the 10th year following the year of your parent’s death. For example, if your parent passed away in 2024, you would have until December 31, 2034, to empty the account.

You have flexibility in how you take the distributions during this 10-year window. You can take payments periodically or wait and take the entire amount in the final year. However, if your parent had started taking their own Required Minimum Distributions (RMDs), you are also required to take annual RMDs in years one through nine. Failure to withdraw the required amount results in a 25% penalty on the portion that should have been taken.

If you qualify as an “Eligible Designated Beneficiary” (EDB), you are permitted to take distributions over your own life expectancy, a method called the “stretch” provision. This allows for smaller annual withdrawals, extending the period of tax-deferred growth. The annual withdrawal amount is calculated using the IRS’s Single Life Expectancy Table based on your age.

A special transition rule applies to a minor child who is an EDB. The child can use the stretch provision only until they reach age 21. Once the child turns 21, they become subject to the 10-year rule, and the 10-year clock begins at that point.

Available Withdrawal and Rollover Options

Once you understand your beneficiary status and distribution timeline, you must decide how to manage the inherited funds. The most common strategies involve moving the money out of the parent’s old 401(k) plan. Your primary options include:

• A direct rollover to an Inherited IRA. This is the most frequently used option, involving the transfer of funds into a new Beneficiary IRA titled in your name. This move gives you control over investment choices while keeping the funds in a tax-advantaged account. A rollover does not change the underlying distribution rule that applies to you.
• A lump-sum distribution. This means withdrawing the entire account balance at once. While this provides immediate access to cash, the entire pre-tax balance is added to your regular income for that year, which can push you into a higher tax bracket.
• Leaving funds in the original 401(k). Some plans may permit you to leave the funds in the deceased parent’s account, but many require non-spouse beneficiaries to take a distribution. If the plan allows you to remain, you may face limited investment options and have to communicate with your parent’s former employer for administrative needs.
• Disclaiming the inheritance. This is a formal, irrevocable refusal to accept the assets. If you disclaim the 401(k), the funds pass to the next contingent beneficiary. This action must be completed through a qualified disclaimer, which has a strict deadline of nine months from the date of death.

The Process for Claiming and Managing the Funds

Your first action is to contact the 401(k) plan administrator, whose contact information can be found on an old account statement. You should identify yourself as the beneficiary and ask for the forms and procedures required for a non-spouse beneficiary to make a claim.

Next, you will need to submit the required documentation, which includes a certified copy of the death certificate and the plan’s distribution or claim form. On this paperwork, you will formally declare your chosen option, whether it is a direct rollover or a lump-sum distribution.

If you choose to execute a rollover, you must first open a new Inherited IRA. The titling of this new account is precise and must read something like: “[Parent’s Name], Deceased, for the benefit of [Your Name], Beneficiary.” You will provide the new account information to the 401(k) plan administrator, instructing them to make a direct trustee-to-trustee transfer.

Should you opt for a lump-sum distribution, you will provide your bank account information on the plan’s distribution form. The plan administrator is required to withhold 20% of the distribution for federal income taxes. This withholding is an estimate, and your final tax liability could be higher depending on your overall income.