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Thin(k) About Your 401(k) Plan: How Will My Beneficiary(s) Receive My 401(k) Account When I Am Gone

In a 401(k) plan, you are allowed to leave the money in your account to a named beneficiary(s) upon your death.  This is a nice feature because the money goes directly to the beneficiary(s) without having to go through your estate.  But how does this happen when one is gone?

If you don’t want to tell your beneficiary(s) now, you need to have a plan in place to notify your beneficiary(s) when you are gone.  It makes sense that the beneficiary(s) needs to know the account exists and that they are entitled to it.

For the beneficiary(s) the process should be simple.  They will need to notify the recordkeeper that holds the deceased’s account and follow the steps necessary to claim the benefit, which will likely require them to provide a death certificate.  While the claims process may be simple, the way in which a beneficiary may receive the money and the tax implications are a bit more complex.

Each 401(k) plan has rules that determine a beneficiary’s options for receiving the money in the account.  The plan document or summary plan description is a good place to look for these rules.  The distribution rules could allow for any of or multiple of the following options as well as others:

  • Full or lump sum distribution – the plan distributes all the money to the beneficiary.
  • Spouses only can roll the money into their own 401(k) or IRA.
  • Non-spouse beneficiary(s) may be able to roll the money to an Inherited IRA.
  • If the account owner died after 2021, the beneficiary could take the withdrawals over a ten-year period after the account owner’s death.

Of course, these distribution options come with their own tax implications.

  • A lump sum distribution will trigger taxes due on the full amount in the year of the distribution.
  • A spouse that rolls the money into their own 401(k) or IRA avoids taxation until such time as they withdraw the money from their own account.
  • If the beneficiary is allowed to spread the distributions over ten years and leave the money in a tax advantaged account like the 401(k) or an inherited IRA, the money continues to grow without taxes on interest and dividend income or capital gains. However, each periodic distribution over the ten-year period will be taxed.

As you can see, while accessing the money left to a beneficiary could be simple, the decision of what to do with it has numerous complexities.  I would highly recommend a beneficiary consult with a tax professional and financial advisor prior to making any decision regarding the distribution of the 401(k) account.

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