401(k) Beneficiary Rules for Non-Spouses

Understanding 401(k) non-spouse beneficiary rules is key for anyone planning their estate and retirement. When a non-spouse inherits a 401(k), the distribution options differ significantly from those available to a spouse. Non-spouse beneficiaries must follow specific guidelines regarding withdrawals, which can impact both taxes and the timeline for accessing the funds. Knowing these rules can help beneficiaries maximize the benefits of their inheritance.

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Inherited 401(k)s are retirement accounts that are passed down to beneficiaries after the account holder’s death. These accounts can be inherited by spouses, non-spouses or other designated beneficiaries, each facing different rules and options for managing the inherited funds.

When inheriting a 401(k), the beneficiary can choose from several options, depending on their relation to the person who died. Spouses typically have more flexibility than non-spouses for how they can structure and time their withdrawals. 

The rules and regulations for inherited 401(k)s have evolved over the years –  particularly with the passing of the SECURE Act in 2019. This law, which was followed by the SECURE 2.0 Act of 2022), introduced significant changes to distribution timelines for non-spouse beneficiaries, including the establishment of the “10-year rule.” 

Beneficiaries were previously allowed to stretch distributions over their lifetimes, but the SECURE Act now mandates that non-spouse beneficiaries who inherit a 401(k) account withdraw the entire balance within 10 years following the account holder’s death. 

Meanwhile, if the original account owner had already begun taking required minimum distributions (RMDs) from the account, the non-spouse beneficiary must continue to take RMDs “at least as rapidly” as the deceased, according to the IRS.   

It is incumbent on the beneficiary to be aware of these rules, as the consequences of violating them are potentially significant. The SECURE 2.0 Act lowered the penalty for missing RMDs from 50% to 25% – still a significant cost. However, if the mistake is rectified promptly, the excise tax can be further reduced to 10%. To avoid this penalty altogether, it’s crucial to ensure that RMDs are taken as required.

The 10-year rule primarily applies to non-spouse beneficiaries who inherited IRAs or 401(k) accounts from someone who died on or after Jan. 1, 2020. This includes children, grandchildren, friends and other non-spousal relations. 

For beneficiaries who inherited 401(k) accounts from individuals who died before Jan. 1, 2020, the old stretch IRA rules remain in effect. Under these now-outdated rules, non-spouse beneficiaries could take distributions over their life expectancy, potentially reducing the tax impact of those annual withdrawals. 

1. Minor children of the account holder (until they reach the age of majority)
2. Disabled individuals as defined by IRS criteria
3. Chronically ill individuals with a condition that impairs their ability to work or perform daily living activities
4. Individuals not more than 10 years younger than the deceased account holder, such as siblings close in age
5. Certain trusts if the trust meets specific requirements set by the IRS for eligible beneficiaries

These exempt beneficiaries can generally stretch distributions over their lifetime, rather than being subject to the 10-year withdrawal requirement.

The primary distinction between spousal and non-spousal beneficiaries lies in rollover options and distribution timelines. Spouses can opt to treat the 401(k) as their own, offering more flexibility and potential tax deferral. Non-spouses, however, must adhere to the 10-year rule, leading to a more accelerated distribution schedule.

A spouse-beneficiary of a 401(k) can:

• Roll the account over into their own IRA: This allows the surviving spouse to treat the account as their own, potentially deferring distributions until they reach age 73 – the age at which RMDs begin.
• Take distributions as a beneficiary: Income taxes will be due on the money. 
• Leave the account in the deceased spouse’s 401(k) plan: They can also simply treat the account as if it was their own all along and leave it in the plan. 

Generally, distributions from an inherited 401(k) are subject to ordinary income tax, meaning that the beneficiary will pay taxes at their current income tax rate on any withdrawals they make.

However, if the funds remain in the account or are rolled over into another tax-deferred account like an inherited IRA, they will preserve their status. 

Taking a lump-sum distribution from an inherited 401(k) is another option, but doing so results in the entire amount being taxed as ordinary income in the year it is received. This can significantly increase the beneficiary’s taxable income and may push them into a higher tax bracket.

Understanding the distinct rules for non-spouse beneficiaries of 401(k) accounts is vital for tax planning and cash flow management. The SECURE Act’s introduction of the 10-year rule has significantly altered distribution options, requiring non-spouse beneficiaries to empty the inherited accounts within 10 years of the original account owner’s death or face tax penalties unless they qualify for an exemption. 

• 401(k)s aren’t the only type of accounts that have beneficiary designations. Ensure that all your financial accounts, including life insurance policies and bank accounts, have designated beneficiaries. These designations often supersede the instructions in your will, so it’s crucial they are up to date. Periodically revisit and revise your beneficiary designations, especially after key life changes, to ensure they match your current estate planning intentions.
• A financial advisor with estate planning expertise can be a valuable resource as you plan for what will happen to your assets when you’re gone. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

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