Workers can access the best retirement plans in the United States without lifting a finger. In fact, most employers offer all the pros and cons of the 401k plan; one of the most famous retirement accounts in the country. Although planning for retirement is a smart decision, any saver, retired or not, could die before enjoying their money, which is why many ask “what happens to the 401k if I die?” In that case, who inherits the 401k? We explain it below.
Although life expectancy in the United States has fallen after the pandemic (from 76.3 and 81.4 years for men and women to 74.5 and 80.2 years, respectively), it is still quite high relative to the world average. However, being prepared for any scenario is key when it comes to saving, which leaves us with an open question: what happens to the 401k if you die and who inherits the benefits?
Table of Content
- The importance of estate planning for retirement plans
- What happens to the 401k in the event of death?
- Who inherits the 401k?
- What is needed to claim a legacy 401k?
- Can creditors keep the 401k in the event of death?
- How long does it take to transfer 401k funds in the event of death?
- Taxes on Legacy 401k Retirement Plans
- Inherit a 401k as a surviving spouse
- Inherit a 401k as a declared beneficiary
The importance of estate planning for retirement plans
Estate planning is essential for the future. Perhaps in the years of youth, not many think about it. But as the body ages and responsibilities (marriage, children and dependents ) increase, families begin to draw up an action plan to protect themselves against certain scenarios, such as the unexpected death of a family member.
Generally, those new to estate planning think of two things: purchasing life insurance that allows survivors to maintain an optimal level (that is, that they have all their needs covered) and analyzing the retirement system.
Knowing how retirement plans work and how much a retiree earns in the United States allows you to obtain relevant information about the operation of the savings fund. Once all the rules of the game are clear, it only remains to decide who inherits the 401k in the event of the death of the owner: the surviving spouse, the beneficiaries or both.
In other words, savers, whether retired or not, should make sure they have a life action plan in place to ensure that the money accumulated in their 401k is transferred to whoever they want in the event of an untimely or unexpected death. In the absence of a declaration of beneficiaries, the surviving spouses will be the immediate heirs of the 401k.
The qualification of an heir and the actions that he can exercise will depend on his relationship with the owner and the type of retirement account that we are talking about. The profitability of the plan, on the other hand, will be tied to the income taxes to be paid the following year; at least if the heir elects full collection of the funds.
Remember that the funds deposited in a 401k account are tax deferred, which means that, in the event of a death distribution, all taxes will have to be paid (unless the money is transferred to another retirement account).
What happens to the 401k in the event of death?
When a 401k owner dies, the money in the account must be divided among the beneficiaries. When there is only one beneficiary, the distribution can be done in a single transaction easily and quickly.
If there are multiple beneficiaries, the distribution will be based on age and official US life expectancy. Older beneficiaries will receive more money than younger ones if they choose required minimum distributions (RMDs).
Of course, there are other withdrawal and redistribution options that could mean a higher return or less money lost to Uncle Sam. Later, we will talk about this topic.
Who inherits the 401k?
The surviving spouse automatically inherits the 401k plan money as long as:
- Be officially declared as beneficiary on the account form
- If not declared, there is no other registered beneficiary who can inherit
What does this mean? That if a 401k account owner names someone else as a beneficiary, the surviving spouse would not automatically inherit. However, in order to name a beneficiary other than a spouse, the saver’s husband or wife must sign a living waiver. Otherwise, the appointment will not be valid.
Note. In the absence of beneficiaries, the surviving spouses automatically inherit; this in compliance with US law. If the saver is not married but has a cohabiting partner, he must officially name her as beneficiary, since the regulations only protect the spouse in the event of marriage.
As you can see, not only the surviving spouse can inherit the 401k. Everything will depend on what the account holder has arranged in life. When the saver opens his 401k retirement plan or an IRA account, he has the option of naming other beneficiaries, including or not the surviving spouse. So, let’s recap: who inherits the 401k?
- The primary heir is the surviving spouse, who may be declared the sole heir (when not named as a beneficiary on the form) or as a beneficiary on the appropriate form.
- The account owner may designate other beneficiaries. We are talking about close relatives (children, siblings, nephews, etc.) or third parties to the family.
What is needed to claim a legacy 401k?
Terms and requirements vary somewhat depending on the 401k plan provider. However, in most cases it is enough for the beneficiaries to present the death certificate to the financial authority in charge of managing the account.
Can creditors keep the 401k in the event of death?
No. Fortunately, both 401k retirement plans and various types of IRAs and Roth IRAs are protected from creditors. The only way a creditor can receive money from your 401k account after your death is if you order the funds transferred to your estate.
This is why experts recommend naming the spouse as the primary beneficiary, since most state laws in the United States protect the surviving husband or wife.
In addition, a deceased’s estate is not only closer to the hands of creditors: should you exceed the current year’s federal or state estate tax exemption, you could be subject to much higher taxes.
Note. For 2021, the federal estate tax exemption stands at $11.7 million. While it’s an exorbitant amount that shouldn’t worry most taxpayers, it’s always good to prepare and protect yourself for any scenario.
How long does it take to transfer 401k funds in the event of death?
There is no single term to receive the funds from a 401k plan because, in essence, everything will depend on who the beneficiary is. When we talk about the surviving spouse, the transfer is usually faster (before the end of the year of the owner’s death).
Now, other beneficiaries (such as children or third parties) may have to wait a while longer, even years, to withdraw the money through minimum distributions, unless they choose to withdraw all funds from the legacy 401k account and pay all payments. taxes on the spot.
Taxes on Legacy 401k Retirement Plans
What if you are a beneficiary of a 401(k) Plan? Unfortunately, the first thing that will happen is to get you a little closer to Uncle Sam. Taxes for receiving an inherited 401k will vary depending on your relationship to the account owner and the withdrawal or distribution method you have chosen. That is why, before making the claim, you have to think very carefully about how to manage the money in the fund.
Inherit a 401k as a surviving spouse
If the beneficiary is the surviving spouse of the account owner, you have several claim options :
1. Transfer the money to your retirement account
Rolling over funds from an inherited 401k to a surviving spouse’s 401k or IRA plan is automatically tax-deferred in the United States; at least it will be that way until retirement withdrawals begin to be received.
2. Opt for Required Minimum Distributions (RDM)
If the surviving spouse is age 72, you can choose to take required minimum distributions (RDMs). This will allow you to make small withdrawals of money to reduce the amount of taxes on an annual basis. As you can see, the RDM could be a new way to defer the payment of taxes.
3. Leaving legacy 401k money where it is
The surviving spouse is a special beneficiary and, as such, can continue to manage their late husband’s or wife’s 401k account. This option will only be valid if:
- The account owner dies before reaching the age of 70½
- The surviving spouse is under the age of 59½
When it is decided to keep the legacy 401k account, RDMs will not begin until the year in which the (now deceased) account owner would have reached statutory age. After that, the spouse can withdraw part of the money without having to pay the 10% penalty for early withdrawal or, alternatively, transfer the funds to their own retirement account.
4. Deposit the funds in an AB trust
AB trusts are designed to double the maximum estate tax exemption so that heirs can receive the proceeds of the estate without facing a large tax bill.
If the marriage, before the death of the owner of the 401k account, established a living trust as an estate plan, they can order the transfer of funds from one account to another.
In this case, income tax will be deferred until withdrawals begin.
Inherit a 401k as a declared beneficiary
Non-spouse beneficiaries also have various claim options, such as:
1. Withdraw funds from legacy 401k account
In this case, income taxes will have to be paid. Each beneficiary will receive an amount of money that will form part of the tax base for that year. Our advice? Check how much is the minimum to make taxes and calculate what impact the receipt of funds will have on your IRS return before opting for this alternative.
Note. Choosing this option could advance you in the federal income tax brackets. If you are not sure what to do, talk to your trusted accountant.
2. Take required minimum distributions
Applies to beneficiaries who are minor children of the account holder, dependents with disabilities or illnesses, or any person up to 10 years younger than the deceased holder. In this case, the money from the 401k plan will be distributed based on the life expectancy of each beneficiary. The advantage of implementing this strategy is that it will allow beneficiaries to spread the distribution of inherited funds over time (and also the payment of taxes).