Q&A: How Do I Inherit a Relative’s 401(k) plan?

with No Comments

A user on the personal finance subReddit recently asked (paraphrased):

My aunt passed away, and in her will she has her 401k split between her 5 grand-nephew’s; my brother and I and my three cousins. … What can I do with it? I’m 19 years old and currently in college.

You said that the Will left the 401k to you. If that is actually the case, then you can sit back and wait for instructions from the executor of the estate, as it will be their job to make decisions on how those assets are divided. Likely some of the steps described below will be similar, but the executor will be permitted to make many decisions for you.

That being said, it is more common to inherit a 401k from beneficiary designations on the account rather than a Will. Assuming that is how you were designated and “Will” was just a shorthand, here’s what you do:

1. Contact the 401k custodian or the employer who sponsors the plan and identify yourself as an heir. Ask them what paperwork you need to inherit your share and get a copy. Also, ask them if any of the assets you are inheriting are after-tax Roth assets.

2. Pick a custodian to open your own accounts that will inherit these assets. I recommend either Vanguard or Charles Schwab.

3. Open a inherited traditional IRA and (if there were Roth funds) an inherited Roth IRA. To open these accounts, you will likely need to use paperwork (as an inherited IRA is not usually an easy online account open) but you can call the custodian to get them to walk you through the paperwork. Also, you will often need some of your aunt’s information like her legal name, date of death, and social security number.

4. Once the accounts are open, fill out the paperwork to transfer the funds from the 401k to the appropriate inherited IRA(s). Be sure to move any Roth 401k balances to an inherited Roth IRA. Avoid options like “lump distribution.” Elect to have no withholding. If you do this right, you will just be transferring accounts and will not be creating a taxable event.

5. Most often the employer plan sells assets to cash and transfers it all in cash, so you’ll need to pick new investments for the new accounts. Even if they do manage to transfer the assets in kind, sell those funds. 401k’s are notorious for having expensive fund choices and you don’t want your investment returns burdened by those fees. If you are looking for free recommendations, Marotta’s Gone Fishing portfolio has a calculator where you can put your age in and get an asset allocation of low cost funds.

6. Inherited IRAs are subject to their own unique required minimum distribution rules. After the recent SECURE Act, the rule is that beneficiaries must distribute the funds out of the account within 10 years of the date of death. If you have not yet reached the age of majority in your state (sometimes 18, sometimes 21) then you might be able to get a few more years in thanks to the minor exception. When you do distribute the funds, any traditional IRA distributions will be taxable. As you are likely in a low tax bracket now, you may want to do some math / projections to plan out if making a few small annual distributions might manage your tax bill better or if waiting is better. Any inherited Roth assets you should let sit in the account until the year you need to distribute. Those assets are after-tax so you will want to keep the growth in the account where it will not be taxed again for as long as possible.

7. People go broke spending their windfalls. The rule is that you should save 97% of any windfall. Open a regular brokerage account, such as an individual account (here is our guide to opening one at Schwab), to transfer any distributions into so you can continue to save and invest. If you have earned income, consider using those distributions to start funding your own Roth IRA.

I’m sorry for your loss. Let me know if there’s any other way I can help.

Photo by Karim MANJRA on Unsplash

Follow Megan Russell:

Chief Operating Officer, CFP®, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.