Inheriting a 401k

Gary Alt |

Inheriting a 401k

Q: My mother died earlier this year at the age of 69. She had been single for the past 25 years and had accumulated a significant amount of money in her company’s 401(k) plan. The 401(k) plan’s administrator says their plan requires that I take the money from the plan either in a lump sum or over the next five years. Which do you recommend?

A: If those are your only two choices, and you don’t need the money immediately, I recommend taking the money over 5 years. It is almost always better to pay taxes later rather than sooner.

However, there is a third option that you really should consider—rolling your mother’s 401(k) balance directly into an inherited IRA. An inherited IRA will allow you to stretch your distributions over your lifetime thereby reducing your immediate tax burden and allowing the money to grow tax-deferred for years to come. If you are going to roll the money into an inherited IRA, you need to be careful. Here are some things to consider.

First, you need to open a special type of IRA account called an inherited IRA. Federal law requires that all IRA accounts be held by a custodian. The custodian’s role is to keep the IRA assets safe and to make sure the IRA complies with the applicable rules and regulations of the IRS and the Department of Labor. Examples of well-known IRA custodians include Charles Schwab & Co., TD Ameritrade, Vanguard and Fidelity. If you contact any of these custodians, they can help you set up an inherited IRA.

Second, make sure you instruct the 401(k) plan administrator to do what is called a “trustee-to-trustee transfer” from the 401(k) plan to the inherited IRA.  It is vital that the plan administrator transfer the assets directly to the inherited IRA custodian. If the administrator sends a check to you, the IRS will deem the entire amount to be a taxable distribution. An experienced financial advisor can help make sure this is done correctly.

Because your mother died at age 69, she was not yet taking required minimum distributions (RMDs) from her account. However, IRS rules require you as the owner of an inherited IRA to begin taking RMDs before the end of the year following the year in which your mother died. The rules for RMDs on inherited IRAs are a little tricky, so it makes sense to get some expert help. If you do not take a distribution when required, the IRS will levy a penalty equal to 50 percent of the late or missing distribution.

Your RMD is calculated using the value of your inherited IRA at the end of each year and a life expectancy factor based on your age. Inherited IRA holders use the Single Life Expectancy table published by the IRS. A brief example will show how this works.

Let’s suppose you turned 44 years old this year, the year your mother died. Your first RMD will be due next year. Using the IRS Single Life Expectancy table, you find that the life expectancy factor for a 45 year-old (the age you will turn in the year following the year of your mother’s death), is 38.8. If we assume your inherited IRA will be worth $750,000 at the end of this year, your RMD for next year will be $750,000 divided by 38.8, or $19,330. Each year thereafter, the initial life expectancy factor will be reduced by 1. In other words, if the first year’s life expectancy factor is 38.8, the following year’s factor will be 37.8, then 36.8 and so forth. Your RMD for each year will be calculated by dividing the value of the inherited IRA on the previous December 31 by the current life expectancy factor.


Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell,   2340 Garden Road Suite 202, Monterey, CA  93940 or email them to