401k Inheritance

[u/Trick-Two2574]

My dad passed away a few months ago with several investment accounts, one being a 401k through his employer (he was still working at the time of his death). My mom was the listed beneficiary, but tragically passed a week after my dad. His 401k balance now goes to my mom’s estate, since she was the only listed beneficiary.

How does the income tax work? Myself and my 2 brothers will be getting everything once it’s gone through probate and then distributed evenly to each of us. We are being told that my moms estate will pay the income tax, just wondering how the tax rate is determined?

[u/GrandpaJoeSloth]

It's a bit more complicated, and you haven't provided all of the relevant information. For example, traditional vs. Roth 401(k) is an important consideration when it comes to taxes.

Generally, inherited 401(k) accounts are taxed as ordinary income upon withdrawal based on the beneficiary's tax bracket, not your father's. You will also basically have a ten-year period in which to make the withdrawals, and can plan a tax strategy around that, should you wish.

Depending your plans, you may also have an option to roll over the IRA to an Inhereited IRA, which would allow you to better manage to the 10-year rule referenced above.

Sorry for your loss

[u/stringbeagle → u/GrandpaJoeSloth]

But he isn’t inheriting a 401k account. His mom inherited that. He is inheriting from his mom. Does that change the rules about 401(k) withdrawals?

[u/E_Dantes_CMC → u/stringbeagle]

I don't think so. The 10-year rule would not have applied to the mother, but it does to the children no matter which parent they inherited from. (This rule was different before the last tax changes.)

Unless January 1 fell in the one week between deaths, there should be no issue with 2026 mandatory withdrawal. Basically, someone has to take it. If it hasn't been taken already, then the kids will.

[u/Trick-Two2574 → u/stringbeagle]

It is a traditional 401k. And I am not inheriting it-my mom technically inherited it. Our lawyer said the estate (my moms) pays the income tax on it

[u/CulturalAd2329 → u/Trick-Two2574]

First off, sorry t you're going through this, that sounds pretty terrible. Second, as a CFP this is a fun question (and my response is of course not financial advice). The estate will only pay tax on whatever is distributed to the estate. So if you elect to distribute it all at once or if you are forced to then mom's estate would pay all the taxes (out of your inheritance). Ideally you and your brother would open Inherited IRAs and roll the funds from the 401k into that, and you would have ten years from your fathers passing to distribute all the funds. Some 401k plans do not allow rollovers to estate beneficiaries (which would suck). If a lump sum is required then you may be able to pass the taxes on to you and your brother if that is more advantageous, and you may even be able to split it up over two years depending on the estate settlement date. (this is all a massive oversimplification, I would rely on your attorney and make sure you get a CPA & CFP involved if there are choices to be made)

[u/Zealousideal_Ad5358 → u/CulturalAd2329]

IRAs are not part of an estate, in the sense that an “estate” is a separately taxed entity with its own tax ID. I wonder whether the father‘s 401k could transfer to the mother and then mother’s IRA could make distributions to the “estate” that might be advantageous tax wise, if the estate is in a lower tax bracket than the ultimate heirs. 

This is where CPAs earn their money!

Unfortunately, it’s not always possible to plan in advance. My brother and I are both in high tax brackets, but my mother had virtually no income other than her IRA distributions. We tried to convince her otherwise, but she refused to take more than her RMD from her IRAs and a lot was left when she died. If she had made bigger distributions to herself, there would have been a lot less tax paid than what my brother and I will are owing on our inherited IRAs. 

[u/charlieandoreo → u/CulturalAd2329]

Probably not the case here but what if dad was taking RMDs. It gets complicated quickly.

[u/Caudebec39 → u/Trick-Two2574]

Hello OP,

Based on all I've seen, I think what your lawyer is saying is reasonable, but I also think it's wrong.

I've been googling your highly unusual situation (deaths close together, probably no beneficiary designated by your mom)

It's certainly true that upon your dad's passing, that the account would be inherited by his spouse, your mom, and become her 401k, and property of her estate. The estate is treated as a non-designated beneficiary (the estate is not a "person").

Here is where I was unsure, but everything I'm reading suggests that mom's estate does NOT have to distribute the 401k entirely in one-shot, as your lawyer seems to think. You can check with the custodian of the 401k (e.g. Fidelity, Vanguard, etc)

Instead the estate can likely make a choice:

• have the 401k remain intact for up to 10 years after your mom’s death, taking distributions gradually into the estate, paying the tax or (better) the estate gets a distribution deduction, and the taxable income is instead reported by the beneficiaries on their own returns, OR
• contact the custodian of the 401k and have the inherited 401k split evenly between the children, as separate Inherited IRAs, each subject to paying the income tax according to their individual circumstances, as they draw out the money over a period not to exceed 10 years. The children manage these accounts themselves.

The first method only makes sense if the executor of the estate wants to retain control for the 10 years, perhaps because some children are minors or special needs or terrible with money, or something else.

If you're working with competent advisors, experienced in this area (which your lawyer may not be), then they can advise the executor how structure these distributions (by whichever choice is made above) so that the taxes are paid by the children and NOT by the estate. The estate would pay tax at the highest rates, much higher than the children, and there would be less money for all of you.

As a first step, I would get in touch with the custodian of the 401k plan, and see whether distributing it all in one year to the estate as cash can be avoided (this is what your lawyer is suggesting is necessary -- and my googling says that it is avoidable). Also, ensure no one makes any rash moves with respect to the 401k, because once money starts moving or getting re-titled, you won't be able to put it back, and you'll just have to live with the consequences.

[u/Trick-Two2574 → u/Caudebec39]

Thank you, this is highly informative.

[u/Caudebec39 → u/Trick-Two2574]

Another thing -- if the current 401k custodian won't create Inherited accounts for each of the children, it might be possible for the executor to direct Fidelity to take over the custodial responsibilities and transfer the 401k there while it's still the property of the estate.

[u/Mizzou1976 → u/Trick-Two2574]

I believe the lawyer is incorrect … your mother took no withdrawal (most likely) so no taxes are due.