What Happens to Your 401(k) When You Die?

Key Points – What Happens to Your 401(k) When You Die?

Reflecting on One of Benjamin Franklin’s Famous Quotes
Understanding What Happens to Your 401(k) When You Die Is Important If You Want to Leave a Legacy
Updating Your Beneficiaries
What Are the Distribution Rules for Your Beneficiaries?
6-Minute Read

What Happens to Your 401(k) When You Die?

Nearly 235 years ago, Benjamin Franklin famously said that nothing is certain except death and taxes.₁ Taxes can be a lot more fun to talk about when you’re working with a CPA and CFP® Professional to develop a forward-looking tax plan designed to create tax savings over your lifetime. And believe it or not, impending death can be easier to talk about when you start thinking about what legacy you want to leave. Today, we’re going to dive deeper into that topic, as we discuss what happens to your 401(k) when you die.

Who Are Your Beneficiaries?

If you have a significant other, children, grandchildren, or other family members who you love dearly, you need to understand what happens to your 401(k) when you die. When you die, your 401(k) typically is inherited by the beneficiaries that you’ve listed on your 401(k) plan. The same applies if you have a Roth 401(k), 403(b), and other workplace retirement plans.

What If You Didn’t Name Any Beneficiaries?

One financial planning faux pas that we’ve seen too many people make is not naming any beneficiaries on the 401(k), IRAs, other retirement accounts, wills, and trusts. Your 401(k) plan will automatically be inherited by your spouse when you die if you don’t name any beneficiaries.

But if you didn’t have a spouse or they were no longer living, that’s where it can get complicated if you didn’t name any beneficiaries. Your 401(k) plan would then go through probate. Do you really want a probate court to decide what happens to your 401(k) when you die? Probate can be a costly and lengthy process, and it can be avoided by naming your beneficiaries (and titling your accounts on any other assets that you want to transfer to your heirs).

Other Important Things to Understand About 401(k) Beneficiary Designations

Remember that you have the option to name multiple primary beneficiaries. If you find yourself in that situation, you need to allocate a certain percentage of your 401(k) to each beneficiary. Just make sure that all the percentages add up to 100%. You can also name contingent beneficiaries that will inherit your 401(k) if your primary beneficiaries pass away before you do.

There are a couple of other common mistakes that we’ve seen people make regarding beneficiary designations on their 401(k) that we want you to avoid. Make sure that you don’t name your estate as a beneficiary. If you do that, your 401(k) will go through probate. It’s also important to realize that if you’ve specified who will inherit your 401(k) in a will and it contrasts with the beneficiaries you’ve named on your 401(k) plan, your plan beneficiaries will inherit your 401(k).

Updating Your Beneficiaries

Have you recently gotten married or divorced? Following any significant life event, don’t forget to update your beneficiaries on your 401(k). Think about this. Let’s say that your first spouse passed away a few years ago. One of the things you should do as a surviving spouse is to update your beneficiary designations.

If you forgot or decide not to update your beneficiaries and get remarried, guess what happens to your 401(k) when you die? Even if you die right after getting remarried, your new spouse will inherit your 401(k).

If you have adult children who don’t see eye to eye with your new spouse, they might not be thrilled that the new spouse will inherit all your 401(k). If you want to ensure your adult children inherit a percentage of your 401(k) when you die after getting remarried, your new spouse will need to provide written consent.₂

What Is a Per Stirpes Designation?

We hope that there isn’t any in-family fighting over your 401(k) after you die or that you’re stuck in the middle of. Let’s take the situation we just reviewed one step further. If you want to distribute your 401(k) equally to your four children, they would each receive 25% of the assets. But what if one of your children dies before you do, and they have two children of their own?

To ensure that your two grandchildren receive the inheritance that was intended for your child, you can make a per stirpes designation.₃ Your three living children would still receive their 25% share and the two grandchildren would receive a 12.5% share.

What Are the Distribution Rules for Your Beneficiaries?

We also want to make sure that you and your beneficiaries are educated on the distribution rules for inherited 401(k)s. There are different rules and options for surviving spouses than there are for non-spousal beneficiaries.

Four Options for Surviving Spouses

Do Nothing: Leaving the 401(k) As Is

If your surviving spouse decides to leave the 401(k) as is, they will still need to take Required Minimum Distributions. Their RMDs will depend on their life expectancy. As of January 1, 2023, the RMD age is 73. It’s set to increase to 75 in 2033. If you were already taking RMDs, your spouse will continue taking them if they are 73 or older. If your spouse is 59½ or older but younger than 73, they can keep taking RMDs or resume taking them once they turn 73 (or 75 if they turn 75 in 2033 or later). Withdrawing funds prior to 59½ would potentially subject them to a 10% early withdrawal penalty.

Roll the 401(k) into Their Own 401(k)/IRA

This option allows money to continue growing in the 401(k)/IRA that your surviving spouse has already established. The same rules regarding pre-59½ withdrawals and RMDs would apply in this scenario.

Keep in mind though that if your surviving spouse will incur taxes if they want to roll over your 401(k) into their Roth 401(k) or Roth IRA. However, once the tax on that conversion has been paid, the distributions and earnings will grow tax-free as long as the account has been open for five years and your surviving spouse is 59½ or older.

Transfer the 401(k) Funds Directly into a New Inherited IRA

Is your surviving spouse also inheriting an IRA from you and wants to transfer the 401(k) they’re inheriting from you into the IRA? This option allows your surviving spouse to make withdrawals without being subject to the 10% early withdrawal penalty if they aren’t 59½ yet.

Lump Sum Distribution

Another option for your surviving spouse is to take a lump sum distribution. Doing so wouldn’t subject them to the 10% penalty. However, it would be taxed as ordinary income, which could lead to them being pushed up into a higher tax bracket.

Distribution Options for Non-Spousal Beneficiaries

Leave the Money in the 401(k)

Non-spousal beneficiaries of 401(k)s can leave the money in the inherited 401(k). However, they need to be aware of the 10-year rule that went into effect when the SECURE Act was passed. The 10-year rule states that the non-spousal beneficiary must take all the money out of the account by the end of the 10th year of the original account owner’s death. Any assets remaining in the account after 10 years will be subject to a 50% penalty.

The IRS has granted relief the past few years for those who have been subject to the 10-year rule by excusing or waiving annual RMDs, including in April with IRS Notice 2024-35.₄ However, the IRS stated in the Notice that the relief isn’t likely to continue.

Transfer the 401(k) Funds into an Existing Inherited IRA

The 10-year rule applies here as well. With traditional IRAs and 401(k)s, it’s important to understand that the funds in those accounts grow tax-deferred. Taxes aren’t owed when the money goes into the account, but the money is taxed when it’s taken out. You need to make sure your non-spousal beneficiaries are aware of that if they’ll be inheriting your 401(k) or IRA.

Remember what we said earlier about Roth 401(k)s and Roth IRAs and how they can provide tax-free growth to your beneficiaries. To review some factors to consider when contributing or converting to Roth accounts, download our Roth Conversion Case Studies white paper.

Roth Conversion Case Studies

Lump Sum Distribution

A lump sum distribution will grant non-spousal beneficiaries immediate access to your 401(k) funds. But again, it’s taxed as ordinary income, so you would need to decide whether it’s worth pushing you into a higher tax bracket.

Do You Have Any Questions About What Happens to Your 401(k) When You Die?

It’s critical to realize that the decisions you make with your 401(k) don’t just impact you. Hopefully this article about what happens to your 401(k) when you die has shed some light on that for you. As you mull over decisions related to your 401(k), don’t forget to download a copy of our 401(k) Survival Guide.

401(k) Survival Guide

If you have any questions about what happens to your 401(k) when you die, start a conversation with our team below.

Schedule a Meeting

We look forward to learning more about your unique situation so we can help give you more confidence that you’re doing the right things with your money (including your 401(k)), freedom from financial stress, and time to spend doing the things you love.

Resources Mentioned in This Article

Downloads

Roth Conversion Case Studies
401(k) Survival Guide

Other Sources

[1] https://constitutioncenter.org/blog/benjamin-franklins-last-great-quote-and-the-constitution

[2] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-death-of-spouse

[3] https://trustandwill.com/learn/per-stirpes-definition

[4] https://www.irs.gov/pub/irs-drop/n-24-35.pdf

Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.