Why This Matters for Your Legacy
For many people, a 401k is one of the biggest retirement accounts they will build in their lifetime. But what happens to those assets after the original account owner dies is often misunderstood, or overlooked entirely. Without a plan in place, your hard earned savings can get tied up in legal proceedings, exposed to unnecessary taxes or distributed in ways that don’t align with your wishes.
Transferring a 401k after death involves more than just naming someone to receive the funds. It requires the right paperwork, updated forms and knowledge of federal law and tax regulations. At Towerpoint Wealth, we provide fiduciary guidance to help you protect your financial legacy and keep your loved ones from unnecessary tax burden or delay, and answer the question, "What happens to 401k when you die?"
What Happens to Your 401 When You Die? The Basics
When a 401k account holder dies, the fate of the account comes down to one document: the beneficiary designation form. This form determines who gets the funds in your retirement account and overrides your will or trust. Whether or not you have an estate plan, your beneficiary designation is what governs the distribution of your 401k.
If you’ve named one or more beneficiaries, the account usually bypasses the probate process and goes directly to them. This avoids delays, additional legal fees and probate court. But if no valid beneficiary designation is on file, or the beneficiary dies before you and no backup is named, then the retirement account becomes part of your estate where different rules and higher tax implications apply.
Keeping Your 401(k) Beneficiary Designation Form Up to Date
You should review and update your beneficiary designation form regularly, especially after a big life event such as marriage, divorce, having a child, or the death of a previous beneficiary. This ensures your account aligns with your current wishes and avoids conflict among family members or potential heirs.
There are two types of beneficiaries you can name:
- Primary beneficiaries: These are the individuals or entities (such as a trust or charity) who are first in line to inherit your 401(k). You can name multiple primary beneficiaries and assign a percentage to each. Just make sure the percentages add up to 100%.
- Contingent beneficiaries: These are backup recipients who inherit the account only if all primary beneficiaries are unable to do so due to death or other disqualification.
Not naming contingent beneficiaries can lead to unintended consequences, such as the 401(k) going to your estate or a default beneficiary under your plan’s rules, often your spouse under federal law.
Spouse vs. Non-Spousal Beneficiaries
Distribution Options for a Surviving Spouse
Spouses get the best treatment under both IRS rules and workplace retirement plans governed by ERISA. A surviving spouse has three options:
- Roll into their own retirement account: This allows the spouse to treat the funds as if they were always theirs. RMDs (required minimum distributions) are delayed until age 73 and tax-deferred growth continues.
- Inherited IRA: A spouse can open an inherited IRA and take distributions based on their life expectancy. This is often the best option if the surviving spouse is younger than 59½ and wants to avoid early withdrawal penalties.
- Lump sum distribution: This involves taking all the funds at once. While it provides immediate access, it also means immediate income taxation. The spouse must pay taxes on the entire amount in the year of distribution, which can increase their income and push them into a higher tax bracket.
Lump Sum Distribution and Inherited IRA Choices for Non-Spouse Beneficiaries
Non-spouse beneficiaries, such as adult children, other family members, or close friends, have more limitations. Most non-spouse beneficiaries must now follow the Secure Act’s 10-Year Rule, which requires the retirement account to be emptied within ten years of the original owner’s death.
Their two main options are:
- Lump sum distribution: This allows the full account balance to be withdrawn immediately, but it also means the entire amount is subject to income tax in that year. Depending on the size of the account, this can result in a big tax hit.
- Inherited IRA: A non-spouse beneficiary can instead open an inherited IRA and manage distributions over the 10-year period. While the income is still taxable, this method allows for more control over when to recognize the income and helps avoid tax spikes.
Note that other beneficiaries, such as entities or trusts that don’t qualify as “designated beneficiaries”, often have different rules and accelerated withdrawal requirements.
Special Cases: Eligible Designated Beneficiaries (EDBs)
Who Is an EDB?
Some individuals qualify as Eligible Designated Beneficiaries under the IRS rules and are exempt from the 10-Year Rule. EDBs include:
- Minor children of the deceased (until age 21)
- Disabled individuals
- Chronically ill individuals
- Anyone less than 10 years younger than the original account holder
Distribution Options for EDBs
Unlike standard non-spouse heirs, EDBs can stretch distributions over their lifetime. This minimizes the annual tax hit and allows the account to remain invested for a longer period, maximizing growth. However, once a minor child turns 21, they too become subject to the 10-Year Rule.
If there are multiple beneficiaries, and only one qualifies as an EDB, other beneficiaries may not get the same treatment unless the account is split.
Tax Implications of Inherited 401(k) Accounts
Traditional 401(k) Distributions
Distributions from a traditional 401(k) are considered ordinary income. There is no step-up in basis, so beneficiaries must pay taxes on the entire amount. If they opt for a lump sum distribution, they may face a significant tax burden in a single year.
Roth 401(k) Inheritance
Roth 401(k) contributions are made with after-tax dollars, and beneficiaries typically receive distributions tax-free, if the account has been open at least five years. Even though earnings may be tax-free, beneficiaries must still comply with RMD rules.
Missed RMDs and Excise Taxes
Starting in 2025, failure to take required minimum distributions will result in a 25% penalty on the missed amount. This can be reduced to 10% if corrected in a timely manner. Having an advisor can help avoid these costly penalties and any liability arising from non-compliance.
Estate Planning Strategies for 401(k) Accounts
Coordinating Your 401(k) With Other Assets
A 401(k) doesn’t go through your will unless no beneficiaries are named. But it must still be coordinated with other assets in your estate to ensure harmony in your legacy strategy.
- Trusts: You can name a trust as a 401(k) beneficiary, but this must be done with care. Trusts that don’t meet IRS “see-through” requirements may be forced to deplete the account more quickly, losing tax advantages.
- Charitable Giving: If you're philanthropically inclined, you may name a qualified charity as a legal entity beneficiary. Doing so can eliminate income tax liability on the 401(k) balance and leave a lasting impact.
401(k) Mistakes to Avoid
Avoiding costly errors can protect your wealth and your heirs. Common mistakes include:
- Failing to update the beneficiary designation form after a significant life event
- Assuming your will overrides your retirement account designations
- Forgetting to name contingent beneficiaries
- Listing multiple beneficiaries without assigning accurate percentages
- Ignoring the distribution rules under the Secure Act
- Failing to consult a fiduciary or tax advisor about distribution strategy and timing
Frequently Asked What Happens to 401(k) When You Die Questions
Can my kids inherit my 401(k)?
Yes. Kids can inherit your 401(k), but unless they’re Eligible Designated Beneficiaries (EDBs), they must follow the 10-Year Rule. This means the entire balance must be withdrawn by the end of the tenth year following the original account owner’s death.
How long does it take for a beneficiary to get 401(k) funds after death?
Typically a few weeks to a few months after the account holder’s death, depending on the plan administrator’s processing time and the accuracy of the paperwork. Make sure your beneficiary designation form is up to date and complete to avoid delays.
Is 401(k) subject to estate tax?
Potentially yes. If your estate exceeds the federal exemption amount, your 401(k) will be included in the taxable estate. Depending where you live, state estate or inheritance taxes may also apply. For planning purposes, consult a fiduciary advisor and get legal or tax advice.
Can a trust be a 401(k) beneficiary?
Yes. A trust can be a named beneficiary, but it must be a see-through trust under IRS rules to retain favorable tax treatment. The trust structure and terms are key. Because these rules are complex, get legal and tax advice as part of your estate planning process.
What happens if I die without a will or 401(k) beneficiary?
Then your 401(k) goes into probate. This means the account will go through the probate process, which can delay access to funds and limit options for your heirs. Easy to avoid: just keep your beneficiary designation form up to date.
Are inherited 401(k)s taxable income?
Yes. Distributions from traditional 401(k) accounts are taxed as ordinary income in the year received. Beneficiaries must plan carefully, taking too much in one year can push them into a higher tax bracket. Roth 401(k) distributions may be tax-free if certain conditions are met.
Can I name multiple beneficiaries for my 401(k)?
Yes, you can name multiple beneficiaries and assign a percentage to each. This gives you more flexibility and allows you to balance how your legacy is passed on to kids, spouses or other family members. Just make sure the percentages add up to 100% and be aware that different types of beneficiaries (individuals vs. trusts or charities) may have different tax rules.
Should I talk to a tax professional when I inherit a 401(k)?
Yes. Inheriting a retirement account can have big tax implications. A licensed tax advisor or fiduciary financial planner can help you understand your distribution options and avoid tax surprises. At Towerpoint Wealth, we do not provide legal or tax advice, but we work with your legal and tax professionals to make sure your plan is integrated.
Can one beneficiary disclaim their 401(k)?
Yes. A named beneficiary can disclaim (refuse) all or part of their inheritance. This must be done within a specific time frame and according to IRS rules. When done correctly, the disclaimed amount goes to the next eligible other beneficiarylisted on the form, often a contingent beneficiary. This can be useful in managing family dynamics or reducing the recipient’s tax burden.
Key Takeaways: How to Protect Your Retirement Legacy
- Always complete and update your beneficiary designation form
- Use contingent beneficiaries to prepare for the unexpected
- Understand your distribution options, especially as a non-spouse
- Evaluate the pros and cons of a lump sum distribution
- Minimize taxes with smart planning and help from a tax advisor
- Coordinate your 401(k) with other assets to avoid conflicts and delays
Your Retirement Legacy
Your 401(k) is more than a retirement account, it’s the result of decades of effort, discipline, and planning. Make sure it continues to serve your goals even after you're gone. Let Towerpoint Wealth help you protect it.
Schedule a Meeting today to start building your comprehensive estate and retirement strategy.
