The taxation of inherited 401k accounts is governed by a range of rules that vary based on the type of plan and your relationship to the original account owner. For US expats or residents subject to tax on their 401k inheritance, a primary concern is how to manage and optimise the tax impact while complying with relevant laws and regulations.
This article will provide actionable advice on how to avoid taxes on 401k inheritance or at least minimise them. It will outline the key rules governing inherited 401k plans for spousal and non-spousal beneficiaries and discuss the associated tax implications.
What You Will Learn
- What is the general tax treatment of an inherited 401(k)?
- What are your options when inheriting a 401(k) as a spouse or a non-spouse beneficiary?
- How can you withdraw funds from an inherited 401(k)?
- How to minimise and plan taxes on an inherited 401(k)?
What Is the General Tax Treatment of an Inherited 401k?
The taxation of an inherited 401(k) primarily depends on the type of account you inherit.
Traditional 401(k) plans are funded with pre-tax dollars, typically through deductions from employees’ gross salaries. In this case, the account owner’s taxable income is reduced by the amount contributed each year, which may be claimed as a tax deduction.
Taxes on traditional 401(k) plans are deferred until withdrawals commence. However, if you inherit a traditional 401(k), you will be liable for income tax on distributions at your own ordinary income tax rate, rather than the rate applicable to the original account holder.
In contrast, Roth 401(k) plans are financed with after-tax dollars, meaning contributions are made from income that has already been subject to tax.
If you inherit a Roth 401(k) plan, you generally won’t be subject to income tax on qualified distributions, provided that more than five years have passed since the original account owner first made a designated Roth contribution.
If this five-year holding requirement has not been met, you may be liable for income tax only on the earnings component of the account balance.
Beneficiaries of Roth 401(k)s are still subject to inherited-account distribution rules (such as the 10-year or life-expectancy rule), even if the withdrawals themselves are tax-free once the five-year rule is satisfied.
What Are Your Options for an Inherited 401k as a Spousal Beneficiary?
For married individuals, spouses are typically the default beneficiaries of employer-sponsored 401(k) plans, although the plan document ultimately governs beneficiary rules and may require spousal consent to name another beneficiary.
Upon inheriting a 401(k), a surviving spouse may choose from several options for managing the inherited funds, each governed by specific rules and tax implications:
- Taking a lump sum distribution
- Leaving the funds within the existing plan
- Rolling over funds into an inherited IRA
- Rolling over funds into their personal 401(k) or IRA
Taking a Lump Sum Distribution
Spouses can receive the funds from the inherited 401(k) as a one-time lump-sum payment. Note that all lump-sum distributions (excluding Roth 401(k) plans that meet the five-year rule) are taxed as ordinary income at the beneficiary’s individual tax rate. If the plan pays the distribution directly to you rather than via a direct rollover, 20% federal tax withholding will generally apply.
Depending on the size of the inherited 401(k) balance and your existing taxable income for the year, taking a lump-sum distribution could push you into a higher income tax bracket and substantially increase your tax bill.
As a result, a lump sum distribution isn’t considered a favoured option for spousal beneficiaries unless they need immediate access to the entire funds.
Leaving the Funds in the Existing Plan
Provided the original account owner’s plan allows it, you may choose to retain the existing plan and leave the funds in it. This approach may be particularly valuable if the inherited 401(k) offers various investment options that you wish to preserve.
Note that you may be required to take required minimum distributions (RMDs) from the inherited account, depending on factors such as:
- Your age
- Your spouse’s age at the time of their death
- The type of account you inherited
Starting in 2024, owners of Roth 401(k) accounts are no longer required to take lifetime RMDs. However, beneficiaries who inherit a Roth 401(k) must still follow inherited-account distribution rules – generally the 10-year rule – although withdrawals are tax-free if the five-year rule is satisfied.
If you inherited a traditional 401(k), you will have to take RMDs, which will be taxed based on your ordinary income tax rate.
There are two primary methods you may utilise to withdraw funds from the inherited 401(k) account. The applicable rules depend on whether your spouse passed away before or after their required beginning date for RMDs, as outlined in the table below:
| Method | If You Inherited a 401(k) Before Your Spouse’s Required Beginning Date (RBD) | If You Inherited a 401(k) After Your Spouse’s Required Beginning Date (RBD) |
|---|---|---|
| Life expectancy method |
|
|
| Ten-year method |
|
|
Rolling Over Funds Into an Inherited IRA
As a surviving spouse, you may roll over funds from the inherited 401(k) into an inherited (beneficiary) IRA. The rollover isn’t considered a distribution, meaning no immediate tax liability will arise. Once you roll over the funds into an inherited IRA, you cannot make additional contributions.
Alternatively, as a spouse, you may elect to “treat the account as your own,” usually by transferring the balance into a regular (non-inherited) IRA, which places the account on your own RMD and penalty schedule.
Rolling Over Funds Into Your Personal 401k or IRA
Surviving spouses often choose to roll over the funds from the inherited 401(k) into their personal 401(k) or IRA, as this method offers unique tax advantages. For instance, RMDs will then be calculated using your own age, allowing you to delay required distributions until you reach the applicable RMD age (currently 73).
If you decide to roll over funds into your personal 401(k) or IRA, you can continue contributing to your account, allowing the investments to grow tax-deferred.
Note that rolling over a traditional 401(k) (with pre-tax funds) into a Roth IRA is treated as a Roth conversion and triggers income tax in the year of conversion.
What Are Your Options for an Inherited 401k as a Non-Spousal Beneficiary?
Non-spousal beneficiaries have fewer available options when it comes to managing inherited 401(k) plans:
- Taking a lump-sum distribution
- Rolling over funds into an inherited (beneficiary) IRA via direct trustee-to-trustee transfer.
- Leaving the funds in the existing plan if the plan document permits.
Taking a Lump-Sum Distribution
Similar to a surviving spouse, a non-spousal beneficiary may withdraw the entire balance of the inherited plan as a lump sum. While this may seem like a simple solution, it could increase your income tax liability for the year in which you take the lump sum.
Because non-spouse beneficiaries cannot take receipt of the funds and then roll them over, any distribution paid directly to you is fully taxable and may be subject to 20% federal withholding. Only direct trustee-to-trustee transfers to an inherited IRA avoid immediate taxation.
Rolling Over Funds Into an Inherited IRA
You may establish an inherited IRA and roll over the inherited 401(k) funds into it. This option allows the underlying assets to continue growing tax-deferred, while the rollover itself is not subject to any fees or taxes.
Note that the following rules apply to inherited IRA rollovers:
- You can’t make additional contributions to an inherited IRA.
- The 10-year rule applies if the original account owner died after December 31, 2019. In most cases, the account must be fully distributed by December 31 of the 10th year following the owner’s death.
- If the decedent died on or after their Required Beginning Date (currently age 73 under SECURE 2.0), annual RMDs are also required in years 1–9, and the remaining balance must still be withdrawn by the end of year 10.
- Failure to withdraw required amounts is subject to a 25% excise tax on the RMD shortfall (reduced to 10% if corrected within two years).
Certain non-spousal beneficiaries are exempt from the ten-year rule, including:
- Minor children of the original account owner
- Beneficiaries who are disabled or chronically ill
- Beneficiaries who are less than 10 years younger than the original account owner
Leaving the Funds in the Existing Plan
You may leave the funds in the inherited account if the plan document permits it. However, for most non-spouse beneficiaries of account owners who died after December 31, 2019, the 10-year rule applies — meaning the account must be fully distributed by December 31 of the tenth year following the original owner’s death.
If the account owner died on or after their Required Beginning Date (currently age 73), annual RMDs are also required in years 1–9, in addition to emptying the account by the end of year 10.
What Are the Options for an Inherited 401k for Minor Children?
Minor children of the original account owner have three options for receiving an inherited 401(k):
- Lump-sum distribution: They can take the inherited 401(k) funds as a lump-sum payment.
- Life-expectancy distributions: Minor children may take annual RMDs based on their life expectancy until they reach age 21. Once they turn 21, the 10-year rule begins, meaning the account must be fully distributed by the end of the tenth year after age 21 (typically by age 31).
- Ten-year rule: Alternatively, they can choose to withdraw funds under the 10-year framework from the start, provided the plan allows this option, but most beneficiaries use the life-expectancy approach until age 21.
Does the Early Withdrawal Penalty Apply to Inherited 401k Plans?
The IRS imposes a 10% early withdrawal penalty on any withdrawals before the age of 59 ½ years, in addition to regular income tax liability.
However, this 10% early withdrawal penalty does not apply to distributions made to inherited 401(k) plans after the account owner’s death, regardless of the beneficiary’s age or the account type.
The exception is when a surviving spouse rolls over the inherited funds into their own 401(k) or IRA (treating it as their own account). In that case, the funds are subject to the normal early withdrawal rules, and withdrawals made before age 59½ may incur the 10% penalty.
How To Avoid or Minimise Taxes on an Inherited 401k?
The following methods may help you reduce and manage the tax burden associated with inheriting a 401(k) account:
- Discuss options with the original account owner.
- Plan your withdrawals.
- Understand and apply the ten-year rule correctly.
- Set up an inherited IRA.
- Consult a financial adviser.
Discuss Options With the Original Account Owner
If you anticipate inheriting a 401(k) in the future, you may discuss strategies for minimising your tax burden with the original account owner.
A suitable option involves converting a traditional 401(k) to a Roth 401(k) during the original account owner’s lifetime.
Roth 401(k) accounts are funded with after-tax dollars, and eventual withdrawals will generally be tax-free for the beneficiaries.
However, income taxes will be triggered on the amount converted in the year of conversion. Since 2024, Roth 401(k) owners are no longer subject to lifetime RMDs, but beneficiaries must still follow inherited-account rules (such as the ten-year rule).
Careful planning of conversion timing is essential to manage tax liability.
Plan Distributions
If you’ve already inherited a 401(k), one of the most effective ways to optimise your tax liability is to plan distributions depending on your income tax bracket. Withdrawals from traditional 401(k) accounts and Roth 401(k) plans that don’t meet the five-year rule are taxed as ordinary income in the year they are taken.
Effective distribution planning may involve:
- Timing larger withdrawals in lower-income years and limiting withdrawals in years when your income is higher.
- Spreading distributions over multiple years to avoid being pushed into a higher tax bracket in any single year.
- Anticipating future income changes, such as a new job, salary increase, or significant bonus, that could affect your tax rate.
If the account owner died on or after their Required Beginning Date (currently age 73), you may also be required to take annual RMDs in years 1–9 under the ten-year rule.
Consider the Ten-Year Rule
The ten-year rule requires most non-spousal beneficiaries (except eligible designated beneficiaries, such as minor children, disabled or chronically ill individuals, or beneficiaries less than 10 years younger than the decedent) to withdraw all funds from a 401(k) account by December 31 of the tenth year following the account owner’s death.
If the decedent died on or after their Required Beginning Date, annual RMDs are required in years 1–9, and the balance must still be fully distributed by year 10.
The rule doesn’t define the structure of these withdrawals—beneficiaries aren’t obligated to take a specific amount each year (unless annual RMDs apply), allowing them to develop a flexible withdrawal strategy.
While this flexibility can be advantageous, skipping withdrawals early in the period may leave a large balance to withdraw in later years, potentially increasing your future tax exposure.
Set Up an Inherited IRA
You can establish an inherited IRA regardless of your relationship with the original account owner. The rollover of funds defers taxes, but only temporarily—you will be liable for income tax once you begin withdrawing from a traditional account.
Only direct trustee-to-trustee transfers from the 401(k) plan are eligible for rollover to an inherited IRA; taking receipt of the funds personally triggers immediate taxation and 20% withholding.
Consult a Financial Adviser
Inheriting a 401(k) involves significant tax implications, and understanding what your options are or how to optimise your tax exposure may be challenging. In such situations, seeking professional guidance is highly recommended. Financial advisers can:
- Assess your individual financial circumstances.
- Identify available options for managing your inherited 401(k).
- Develop a personalised tax optimisation strategy to minimise liability.
Complimentary Inherited 401(k) Tax and Distribution Strategy Review
Managing an inherited 401(k) as a US expat or resident involves complex timing, rollover, and cross-border tax rules. Without a clear plan, distributions may trigger unnecessary income tax or penalties in both the US and your country of residence.
In a complimentary consultation with Titan Wealth International, you will:
- Clarify your options as a spouse or non-spouse beneficiary — including rollover, life-expectancy, and 10-year distribution strategies.
- Understand your tax position for both US and local purposes, including RMD timing, Roth versus traditional treatment, and available treaty relief.
- Receive a personalised action plan designed to minimise unnecessary tax exposure, remain compliant with evolving IRS and overseas regulations, and preserve more of your inheritance.
Key Takeaway
An inherited 401(k) is generally subject to taxation at your ordinary income tax rate upon withdrawal, although the exact treatment depends on whether the account is a traditional or Roth 401(k). Roth 401(k) withdrawals are typically tax-free for beneficiaries if the five-year rule has been met.
Spousal and non-spousal beneficiaries have distinct distribution options, each with different tax and timing implications that affect how the inherited balance is managed and when taxes become due.
This article has outlined these options based on the beneficiary’s relationship with the account owner, explained the key IRS rules governing inherited 401(k) plans, and introduced strategies for minimising—not eliminating—tax exposure.
Beneficiaries face several important financial decisions to ensure compliance, manage timing effectively, and avoid unnecessary taxation. Given the complexity of the rules and potential penalties for missed distributions, seeking qualified tax or financial advice is strongly recommended—particularly for US expats, who may face additional cross-border reporting or treaty considerations.
At Titan Wealth International, our financial advisers have years of experience helping US expats and residents structure inherited 401(k) distributions in a tax-efficient manner. By prioritising a personalised approach and focusing on compliant withdrawal strategies, we can help you preserve more of your inheritance and manage your overall tax liability effectively.
The information provided in this article is not a substitute for personalised financial, tax or legal advice. You should obtain financial advice and tax advice tailored to your particular circumstances and in respect of any jurisdictions where you may have tax or other liabilities. Titan Wealth International accepts no liability for any direct or indirect loss arising from the use of, or reliance on, this information, nor for any errors or omissions in the content.
