Inheriting a 401(k) is more than just receiving a financial asset; it’s stepping into a legacy. Whether it’s the culmination of a loved one’s years of hard work or a thoughtful gift for your future, it’s natural to feel uncertain about how best to manage it. The decisions you make today can profoundly impact the value it provides for years to come. At Mottet Wealth, we’re here to guide you through this journey, helping you make confident, informed choices.
Understanding your options—whether you’re a spouse or non-spouse beneficiary—is the first step to turning this opportunity into a cornerstone of your financial well-being. Let’s explore the paths you can take.
For Spouse Beneficiaries: Expanding on a Solid Foundation
As a spouse, inheriting a 401(k) offers the most flexibility, akin to receiving a well-tended garden ready for the next season of growth. Here are your key options:
1. Lump Sum Withdrawal
One of the most straightforward choices is withdrawing the entire balance as a lump sum. While this provides immediate access to funds, it’s important to weigh the tax implications. The IRS considers this distribution as ordinary income, which could push you into a higher tax bracket depending on your income and the size of the account.
For instance, withdrawing a large sum all at once might meet urgent financial needs—perhaps paying off a mortgage or covering unexpected expenses—but careful planning is crucial to avoid a surprise tax bill. At Mottet Wealth, we can help you navigate these complexities and determine if this choice aligns with your financial goals.
2. Rolling Into Your Own Retirement Account
This option allows you to integrate the inherited funds into your personal IRA or 401(k), providing continuity for your retirement plan. By doing so, the assets continue to grow tax-deferred, ensuring that your long-term savings remain on track.
If the original account holder had begun Required Minimum Distributions (RMDs), you can choose to maintain those or wait until you turn 73 to begin withdrawals, depending on your needs. This strategy can allow the investment more time to grow while aligning seamlessly with your broader retirement plan. With expert guidance, this option can act as a natural extension of your financial journey.
3. Rolling Over to an Inherited IRA
For spouses looking for a bit more flexibility, rolling the funds into an inherited IRA is another attractive route. Unlike a personal IRA, withdrawals from an inherited IRA are not subject to early withdrawal penalties, regardless of your age. This can be particularly beneficial if you foresee needing access to funds sooner rather than later.
Additionally, inherited IRAs often offer a wider array of investment choices, allowing you to tailor the portfolio to align with your goals and risk tolerance. It’s a way to strike a balance between accessibility and tax-advantaged growth.
For Non-Spouse Beneficiaries: Embracing a New Opportunity
If you’ve inherited a 401(k) from someone other than a spouse, the rules and options differ. Though the choices are narrower, they still provide opportunities to grow and manage this financial gift thoughtfully.
1. The 10-Year Rule
For most non-spouse beneficiaries, federal regulations now require the entire balance to be distributed within 10 years. This rule, implemented for account owners passing after January 1, 2020, eliminates the previous “stretch IRA” option for many. However, the flexibility lies in how you manage these withdrawals.
You can choose to spread distributions evenly over the 10-year period, minimizing potential tax spikes by smoothing the income across several years. Alternatively, you might decide to take the full distribution in the final year. While this postpones the tax liability, it carries risks—market fluctuations and a larger tax bill in that final year are notable concerns. A steady, phased approach is often the most prudent choice, allowing for tax-efficient growth.
2. RMDs and Special Exceptions
If the original account owner had begun RMDs before their passing, you must continue these annual withdrawals. Missing a required distribution can result in penalties, but correcting the oversight promptly—often within two years—can reduce the impact.
Certain exceptions to the 10-year rule provide additional flexibility. If you are a minor child, chronically ill, disabled, or within 10 years of age of the original account holder, you may qualify to take distributions based on your life expectancy. This longer timeline can help maximize tax-deferred growth and reduce your annual tax burden. If you’re unsure whether you qualify, we’re here to provide clarity.
Roth 401(k)s: A Tax-Free Opportunity
Inheriting a Roth 401(k) comes with its own unique benefits. Because the contributions were made post-tax, withdrawals are typically tax-free, allowing the full value of the investment to pass directly to you. However, even with Roth accounts, you’ll need to adhere to distribution rules based on your beneficiary status.
Whether you take distributions immediately or let the account grow over the 10-year period, the tax-free nature of Roth funds makes these inheritances particularly valuable. This is a chance to take full advantage of growth potential while planning withdrawals that best fit your needs.
Tailoring the Plan to Your Needs
In some cases, beneficiaries might choose to leave the funds in the original 401(k) plan, if permitted by the provider, to allow continued tax-deferred growth. Alternatively, you may decide to disclaim the inheritance altogether, passing the assets to another beneficiary or the estate. This option might make sense if inheriting the account places you in a higher tax bracket or doesn’t align with your financial plans.
Making these choices isn’t always straightforward, but with the right guidance, you can find a path that fits seamlessly into your goals. Every financial situation is unique, and at Mottet Wealth, we pride ourselves on crafting strategies that reflect the distinct needs of each client.
Building on a Legacy with Confidence
Inheriting a 401(k) is about more than just the financial gain—it’s about continuing a story. Much like tending a farm, managing an inheritance requires care, strategy, and a long-term perspective. With Mottet Wealth by your side, you can approach this transition with clarity and confidence, ensuring that this legacy becomes a meaningful part of your future.
