Recently on our legal forum a user asked, “I am in a financial crisis. I have thought about filing for bankruptcy. Last week my parent’s both died in a car accident. They don’t have many assets, but they do have close to a million dollars in their 401K account. They were over the age of 70 and already withdrawing money from their account. I am their only child. Do I get their money when they die? Can I get it all at one time?”
401K funds: How will they be distributed
Whether you inherit the money in your parent’s 401K account will depend on who is listed as the beneficiary on the account, regardless of what may be stated in your parent’s will. Hopefully, your parents completed the beneficiary form when they opened the account and they listed you as the beneficiary.
Although this does not apply in your case, if your father had died but your mother had survived, she would have been the automatic beneficiary unless your father had specifically designated you as the beneficiary and she had signed a waiver relinquishing her rights to the monies.
What should you do with the money?
Assuming you are the beneficiary and you do inherit your parent’s 401k funds, you have several options. Your first option is to take the money and roll it over into an account called an inherited IRA (you cannot transfer the money into an existing IRA account).
The benefit of the rollover is that you can keep the money, allowing it to grow tax free and avoid cashing out the total amount of the fund. The only caveat to this plan is that you will be required to withdraw a certain minimum amount each year as required by the IRS.
Another benefit is that you can still avoid paying an early withdraw penalty, even if you are under the 59 ½ age limit, because the disbursement of the funds was due to the death of your parents. Some investment companies, however, may automatically withhold a specific amount. Talk to your investment company if you have questions about your parent’s investment fund.
Can I take a lump sum payout of my parent’s 401K?
Another option is to request a lump sum payout. If you make this decision, or your plan requires this option, you can either keep the money or roll it over into an IRA (as discussed above). The lump sum payout must be paid no later than Dec. 31 of the year following the participant’s death.
What type of taxes must I pay?
If you do decide to take a lump sum payout of your parent’s 401K the most important consideration is taxes owed. Taxes must be paid in the year that the distribution is made, and you will be responsible for reporting the distribution and paying the income taxes.
The distribution is considered taxable income and, depending on your tax bracket, the amount of taxes to be paid could be quite substantial. It’s important that you talk to your tax attorney prior to taking the distribution to ensure you understand the tax implications.
If your parents have a substantial amount of money saved in their 401K you may have a nice inheritance. This money may be immediately distributed to you and either rolled over into an IRA or paid out in one lump sum payment.