Your 401k: It’s a sad fact, but we’re all mortal, and we’ll all die one day. This is true whether we have retired or not, and it is a foregone conclusion. According to Vanguard, more than a quarter of all Americans have a 401k plan. This means that one in every four Americans will be forced to deal with a 401k plan after someone dies. That brings us to the crucial question:
What happens to our 401k when we pass away?
In general, what happens to your 401k when you die to determine by a few factors, including whether you have designated beneficiaries, the type of 401k plan you have, and the rules of that specific plan.
If you have designated beneficiaries for your 401k, the money in the account will transfer to them after you die. The funds will distribute in accordance with the 401k plan’s terms. If you do not have any designated beneficiaries, the money in your 401k becomes part of your estate and distribute in accordance with the terms of your will.
What Happens to Your 401 K if You Die Before Retiring?
If you die before retiring, the money in your 401k will be distributed to your beneficiaries in accordance with the plan’s terms. If you have a traditional 401k plan, the funds in your account will tax as income when they distribute to your beneficiaries. If you have a Roth 401k, the same rules apply.
It is important to note that if you die before reaching retirement age, your beneficiaries will unable to contribute to the account. They will also be unable to take advantage of any employer matching contributions that you may have eligible for.
They could also initiate a 401k rollover into an Inherited IRA. “An inherited IRA allows the designated beneficiary to keep the money in the account and take required minimum distributions (RMDs) based on his or her own life expectancy,” according to Fidelity.
Beneficiaries of 401(k) Plans
A beneficiary is someone you name to receive your 401k assets after you die. You may name more than one beneficiary, and you may change them at any time.
Your spouse is usually the primary beneficiary and your children are the contingent beneficiaries, but this is not always the case. Anyone, including your parents, siblings, friends, or a charitable organization, can be named as a beneficiary.
The Internal Revenue Service establishes the rules for 401k beneficiaries (IRS). “If you die before your entire interest is paid out to you,” the IRS says, “your named beneficiary or beneficiaries will receive what is left according to the terms of your plan.”
What Happens to Your 401(k) After You Die
Your 401k funds will distribute to your beneficiaries in accordance with the terms of the plan. If you have a traditional 401k plan, the funds in your account will be taxed as income when they are distributed to your beneficiaries. If you have a Roth 401k, the funds in your account will not be taxed when distributed to your beneficiaries.
To begin the process of transferring the assets into their names, the beneficiaries will need to provide the financial institution with a death certificate. You must fill out and submit the necessary paperwork to the administrator of your 401k plan.
How Long Does the 401k Plan Transfer Take?
The timing of the distribution determines by the rules of the specific 401k plan as well as the financial institution with which you are dealing. For example, I’ve worked with clients whose 401k plans were with Fidelity or Vanguard, and the transition was simple.
In contrast, I’ve had other clients whose 401k plan was through their employer, and it took much longer to transfer the money – in one case, over 6 months!
What You Must Do
You should name a primary and secondary beneficiary for your 401k (and all your other accounts for that matter). When you open the account, you must name a beneficiary (or beneficiaries), and you can change the beneficiaries at any time.
If you do not name a beneficiary, the money in your 401k will become part of your estate and will be distributed in accordance with the terms of your will, which may or may not be what you want.
401k Beneficiary Error – IRL Case Study
I saw several examples of something tragic, those horrific life events that you never think will happen to you, but they do, and it’s these types of moments.
The 401k is the last thing on our minds, but failure to consider it could have financial and emotional consequences. Here’s one that still breaks my heart:
A young couple had only been married for a few years and had yet to start a family, but it was on the horizon. The husband had begun working before meeting his wife and had already stashed away a decent nest egg in his 401k, especially for someone as young as he was.
Tragically, he was killed in a freak accident at work, leaving his family in shock. Because he and his wife remarried, you’d think she’d inherit his entire 401k, right?
Because this young man began working before marrying, he had named both of his parents as beneficiaries on his 401k. After his marriage, he didn’t give much thought to updating the beneficiary form from his parents to his new wife.
This is how a 401k distribution to your spouse should work
Another client went through a similar tragedy, but the outcome was completely different. The wife came to me after losing her husband of more than 20 years unexpectedly.
He had washed the car earlier that morning, as was his custom on Saturdays. He died a few hours later in their bedroom of an unexpected massive heart attack. He was only 55 years old. His 401k was much larger than the young man in the previous story because he was much older and a physician. Imagine how disastrous it would have been if his parents, or anyone else, had been the beneficiary of his 401k plan.
While it’s unpleasant to consider what happens to our 401k when we die, the reality is that many people die before reaching retirement age.
According to the Social Security Administration, approximately one-fourth of today’s 20-year-olds will become disabled before retiring, and approximately one-eighth will die before reaching the age of 67.
What about establishing trust?
If you have a trust, the money in your 401k can be distributed to the trust’s beneficiaries. The rules for distributing the money will be determined by the terms of the trust.
How an A/B Trust Works: An A/B trust divides the trust’s assets into two parts: the “A” trust and the “B” trust. The “A” trust is for the surviving spouse’s benefit and is not taxed when the surviving spouse dies. When the surviving spouse dies, the “B” trust is taxed for the benefit of the children or other beneficiaries.
Changes Made in Response to the SECURE Act
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 amended how 401ks are distributed after death.
Previously, you could set up what was known as a “Stretch IRA.” This meant that your beneficiaries could withdraw funds from your IRA throughout their lives. This allowed the money to grow tax-free for a long time.
This is no longer permitted under the SECURE Act. Most inherited 401k beneficiaries must now take distributions within 10 years of the account holder’s death.
What happens to my 401k if I die intestate?
If you die without a will, your 401k funds will distribute to your heirs in accordance with the laws of intestate succession. If you die without a will, your assets will be distributed in the order listed below. In general, the order is as follows: spouse, children, parents, siblings, and so on.
Can creditors seize my 401k if I die?
No, creditors cannot pursue the funds in your 401k after your death. Your 401k funds are protected from creditors.
By naming a specific beneficiary for the account, you can protect your 401k from creditors. The money in the account will not become part of your estate and will not be subject to creditors as a result of this.
What If I Don’t Name a Beneficiary?
If you fail to name a beneficiary, your assets may be designated to your estate and subject to probate.
Plan ahead to review your beneficiary information once per year and when major life changes happen.
By naming both primary and alternate beneficiaries, you can avoid subjecting your loved ones to the probate process.
What impact does the Secure Act have on my IRA?
What exactly is the Secure Act of 2020? The Setting Every Community Up for Retirement Enhancement Act, also known as the Secure Act, is legislation that modifies some IRA and 401(k) rules, such as the ability to postpone distributions, less flexibility for inherited IRAs, and penalty-free withdrawals for new parents.
Who is impacted by the Secure Act?
The SECURE Act gives small employers with up to 100 employees a tax credit for starting a workplace retirement plan, with an additional credit available if the plan includes automatic enrollment.