Laura answers a listener's question about how 401(k) retirement plan inheritance works.
Laura answers a listener's question about how 401(k) retirement plan inheritance works.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! Today's topic comes from Srinivas, who says:
"Laura, I have been a long-time listener and love your podcast. I need a little help for my sister-in-law, who recently got divorced. But before their divorce order was finalized, her ex-spouse suddenly passed away. She is the beneficiary of half of his 401(k), and their two adult children are the beneficiaries of the other half. Will the three of them inherit it, or does the account have to go into his estate?"
Srinivas, thank you for the question! I'm so sorry your sister-in-law and her family are going through this difficult time. While thinking about your death isn't pleasant, making the right plans is critical.
This post will review what happens to your 401(k) or other workplace retirement plan when you die. Understanding the rules is essential so the people you love get the money you've worked so hard to save.
Welcome back, everyone, and thanks for joining me on episode 883! I'm Laura Adams, an award-winning author, female finance spokesperson, money speaker, founder of The Money Stack, a Substack newsletter, and host of the Money Girl podcast with over 43 million downloads.
If you're getting value from the free content we love creating, subscribe and consider submitting a 5-star rating or review on your podcast app of choice! If you have a question about money for the show, leave it on our voicemail at 302-364-0308. You can also send an email and sign up for the free Money Stack newsletter at LauraDAdams.com.
What is a 401(k) beneficiary?
When you enroll in a retirement account, you will always be prompted to name one or more beneficiaries on a designation form. If you're married, the primary beneficiary is assumed to be your surviving spouse. In fact, if you name anyone other than your spouse as a beneficiary, they must waive their right to inherit your retirement plan in writing.
If you're unmarried or your spouse waives their right to your retirement funds, you can leave it to anyone you wish, such as siblings, children, or even a charity. You can imagine a situation where a widow remarries and wants to ensure her children inherit her 401(k) instead of her second husband. In that situation, a spouse would need to waive their inheritance or give written consent to acknowledge that they're not the beneficiary.
You can have multiple beneficiaries and allocate a percentage of your account to them that adds up to 100%. It's wise to name one or more primary and contingent beneficiaries. For example, you might name your spouse a primary beneficiary and your sister a contingent in case your spouse is also deceased when you die.
If you name retirement account beneficiaries, your account goes to them outside of probate. That's a potentially lengthy legal process that reviews your assets and then transfers them to the new owners. So, Srinivas, your sister-in-law and her children will inherit her deceased ex-spouse's retirement plan outside of any probate proceedings.
RELATED: What should I do with an old 401(k)?
What if my will has a different 401(k) beneficiary?
If you take away anything from this post, be aware that the beneficiaries named in your retirement plan inherit it, even if you have a will that says something else. In other words, retirement beneficiaries supersede your will. For instance, if you leave an ex-spouse as a beneficiary on your retirement plan, they will receive it, even if your will says explicitly to disinherit the ex-spouse!
If you don't name a 401(k) beneficiary and you're married, your spouse automatically inherits the account. But if you have no spouse or retirement plan beneficiary, your 401(k) becomes part of your estate and will go through probate with the rest of your belongings
What is a "per stirpes" 401(k) beneficiary?
Another way to name beneficiaries is "per stirpes," Latin for by roots. Let's say you want your retirement money to go to the children of a beneficiary who dies before you do. In that case, you can use a "per stirpes" designation, meaning their inheritance goes to their child or children.
For example, let's say you're unmarried and your 401(k) beneficiaries are your brother and sister 50/50. Your sister has a daughter, and you'd like her to receive her mother’s portion if her mother dies. But if your sister dies before you, your brother would receive 100% of the account and your niece would receive zero.
However, if you indicate on your retirement plan beneficiary form that your sister's portion is "per stirpes," her daughter would receive 50% and your brother would receive 50%.
How do beneficiaries receive an inherited 401(k)?
If you're a surviving spouse who inherits a workplace retirement plan, you can:
If you're a surviving non-spouse beneficiary, such as a sibling, parent, or friend, you can't roll over inherited 401(k) funds into your retirement account. With limited exceptions, you must empty it within ten years of the owner's death.
Only minor children of the deceased, or those who are chronically ill or disabled who are within ten years younger than the account owner at death, are allowed to spread out required minimum distributions (RMDs) over their life expectancy.
Non-spouse beneficiaries of a 401(k) can take a taxable lump-sum distribution, transfer it to a newly created IRA, or leave the funds in the same account to withdraw over the next decade.
Srinivas, the best starting point for your sister-in-law and her children will be to transfer their inherited portions to a new IRA. If it's a traditional 401(k), they'll open a traditional IRA and need to empty it and pay taxes on withdrawals over a maximum ten-year period.
However, if they inherit a Roth 401(k), they'll open a Roth IRA and won't have any RMDs or taxes to pay. As you can tell, inheriting retirement accounts can be complicated. To prevent any errors, I recommend you get guidance from a qualified tax professional.
Also, remember that after any significant life event, such as having a child, getting married, getting divorced, or losing a spouse, you should update your retirement plan beneficiaries. Depending on your plan, you may be able to complete a beneficiary designation online. As I mentioned, even if you update your will, that doesn't change who inherits your retirement accounts.
READ ALSO: 6 required minimum distribution (RMD) retirement rules you should know
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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