What happens to your 401(k) when you die?

Planning for retirement takes more than saving money in your 401(k). It's essential to have a plan for what happens to your 401(k) when you die. Without a plan, you could be causing more work and stress for your loved ones. And may even leave the people you want to give your money to high and dry. What happens to your 401(k) when you die is complex. Various scenarios and changing legislation can impact what your family can and can't do with your money.

When you die, your 401(k) goes to whoever you have designated as a beneficiary or in your Will. Without a beneficiary, your 401(k) will go into your estate and ultimately through probate.

Deciding what will happen to your money when you die isn’t an enjoyable process. However, it's something that you must do to ensure your money goes where and to whom you chose.

401(k) Beneficiaries

When you join a 401(k) plan or open an IRA, you have the option of assigning a beneficiary to your account.

A beneficiary is an individual or individuals to whom a retirement account will be distributed upon the death of the account holder. Beneficiaries act as a sort of custodian to the account after the account holder is gone.

You can list anyone as a beneficiary, or you can assign no beneficiary.

A Spouse

Listing a spouse as a beneficiary to a retirement account is most common. Regardless, spouses have many protections under federal law what it comes to 401(k) accounts.

A spouse’s written consent must be filed with your 401(k) provider to make any changes to beneficiaries. Without this, they will retain the beneficiary status of your account.

Divorced spouses can retain beneficiary rights even after the divorce is finalized. Some states even require written consent from ex-spouses to remove them as beneficiaries to a 401(k) if not stated directly in the divorce decree.

Someone Else

As mentioned earlier, you can assign anyone as a beneficiary to your 401(k). If you're single, there is no consent needed.

You can name your children, siblings, parents, a close friend, or even a charity as a beneficiary to your 401(k).

Again, if you're married, you will still need written consent from your spouse to add anyone else as beneficiaries, even your shared children.

No Assigned Beneficiary

Another common occurrence is simply not assigning anyone as a beneficiary. An untimely death can leave a 401(k) unprepared for who will subsequently take over.

By not assigning anyone as a beneficiary, the retirement funds go into the person's estate. As a result, the 401(k) funds go through probate, which could be a lengthy process for those with rights to your estate and access to your benefits.

Without assigning anyone as a beneficiary, your money may not go exactly where you want it to go.

How Your 401(k) is Distributed

Your 401(k) beneficiaries have a few options in how they want to receive your funds. There are ways to access the money immediately and ways to allow the funds to continue to grow.

Required Minimum Distributions

If you intend to support your beneficiary for a more extended period, required minimum distributions may be the best option.

Like calculating RMDs for yourself when you reach 59½, your beneficiary can elect to receive equal distributions over a set time.

Income tax will still be due on these distributions; however, any other penalties will not apply.

Lump-Sum Distributions

Your beneficiaries have the option of cashing out your entire 401(k) account in one transaction.

Many plans opt for doing this automatically as it releases their ongoing burden of maintaining an account for an employee that no longer works for the company.

The full amount will be subject to income tax—and if the estate is large enough, estate tax—but there won't be any other penalty to do so.

Rollover Distribution

Rather than cashing out the entire balance of a 401(k), beneficiaries can opt to rollover a 401(k) into a new or existing inheritance account.

401(k)s consolidated into another retirement account continue as if they were in the original account holder's name. No taxes will be due at the time of the rollover. Only during the distribution of those funds would taxes be required

This is an excellent option if the 401(k) administrator requires the full account to be distributed upon the account holder’s death.

Leave the Account in Their Name

If the plan administrator allows it, leaving the account in the deceased's name is also an option.

Leaving the account alone could delay any required action. However, the beneficiary would be required to start taking minimum distributions the year the deceased would have turned 70½.

Changes Made Under the SECURE Act

Recent changes to estate laws have changed quite what is required of 401(k) beneficiaries.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law in December 2019. The bill includes provisions that seek to increase access to tax-advantaged retirement accounts and preventing Americans from outliving their retirement accounts.

How the SECURE Act Affects 401(k) Beneficiary Distributions

In an effort to increase tax income for the federal government, the SECURE Act requires most beneficiaries to withdraw all of the funds in an inherited 401(k) within ten years. This law replaces the required minimum distributions guidelines for those beneficiaries.

No minimum amount needs to be withdrawn from the account each year during the ten-year period. The only stipulation is that all of the funds must be distributed by the tenth anniversary of the account holder's death.

Rollovers of 401(k)s into an eligible retirement account qualify as a full distribution of funds.

Who is Unaffected By This Provision?

These new withdrawal rules don't impact everyone who is a beneficiary of a retirement account.

The full withdrawal requirement does not apply to beneficiaries who the account holder's surviving spouse, disabled, chronically ill, or is not more than ten years younger than the original account holder.

Additionally, if the 401(k) account holder dies leaving minor children, the 10-year period does not begin until the last child turns 18.

Implement and Review Your 401(k) Plan

Remember, properly managing a 401(k) takes more than the initial setup and reviewing your statement occasionally.

Assigning who will acquire your retirement should you die before you've used all of your funds is a critical step.

Discuss your wishes with your beneficiaries and plan how your funds will be distributed to them.

This not only ensures you take care of your loved ones, but your money goes where you want it to go. Without a plan, it could get tied up in bureaucracy, leaving your loved ones fighting to get a hold of what you've left behind for them.