How to Handle Taxes When You Inherit a 401(k)

You cannot avoid taxes on a 401(k) inheritance, but you can delay them or reduce what you owe

When you inherit a 401(k), the money inside is subject to income tax whenever you withdraw it — that is the core rule. The IRS has already let the original owner defer taxes on those contributions and earnings for years, and now that money must be taxed as it leaves the account. You cannot make it tax-free, but the rules do let you choose when you take the money out and how much you take each year, and those choices directly affect your tax bill.

The strategy that works depends on your relationship to the person who died, how much money is in the account, and whether you need the money now or can leave it invested. A spouse has options that other heirs do not. Non-spouse beneficiaries face stricter timelines. The difference between choosing right and choosing wrong can mean paying taxes on the full balance in one year versus spreading payments over a decade.

Key Takeaways

• All withdrawals from an inherited 401(k) are taxed as ordinary income, but you control the timing and amount of each withdrawal.
• A surviving spouse can roll the 401(k) into their own retirement account and delay withdrawals until age 73, the longest possible delay.
• Non-spouse beneficiaries must withdraw the entire balance within ten years of the death, though they can spread withdrawals across those ten years to reduce their yearly tax burden.
• Taking one large withdrawal pushes you into a higher tax bracket for that year, while spreading withdrawals across multiple years keeps you in a lower bracket each year.
• The account custodian (the bank or brokerage holding the 401(k)) will withhold taxes automatically unless you tell them not to, which can leave you short of cash at tax time.

What happens to the 401(k) after death depends on who you are to the deceased

The IRS treats spouses and non-spouses very differently. If you are the surviving spouse, you have the most flexibility: you can treat the 401(k) as your own by rolling it into your own IRA or 401(k), which means you do not have to take any money out until you reach age 73. That delay is the single biggest tax advantage available to a spouse, because it lets the remaining money keep growing tax-deferred for years.

If you are not the spouse — you are an adult child, a grandchild, a sibling, or a named beneficiary who is not married to the deceased — the rules are stricter. Under current law, you must withdraw the entire 401(k) balance by December 31 of the tenth year after the death. You do not have to take it all at once, but it must all be gone by that important date. The IRS calls this the "ten-year rule," and it applies to most non-spouse beneficiaries who inherited after 2019.

A few non-spouse beneficiaries get an exception: if you are disabled, chronically ill, or fewer than ten years younger than the deceased, you may be able to stretch withdrawals over your lifetime. This is rare, and you need to confirm with the account custodian whether you meet the definition. Do not assume you may have access to.

How to minimize taxes by spreading withdrawals across multiple years

The simplest way to reduce your tax bill is to avoid taking all the money in one year. If the 401(k) holds $100,000 and you withdraw it all in year one, that $100,000 is added to your other income for the year, which can push you into a much higher tax bracket. If you instead withdraw $10,000 per year over ten years, each year's withdrawal is taxed at your normal rate, which is usually lower.

You control the withdrawal schedule. The account custodian will not force you to take a specific amount each year — they will only force you to take something by the important date. If you are a non-spouse beneficiary with a ten-year window, you could take $5,000 in year one, $15,000 in year two, $8,000 in year three, and so on. The only requirement is that the full balance is gone by year ten.

To set up this schedule, contact the 401(k) custodian (the bank or brokerage) and ask them to set up a withdrawal plan. Tell them the amount you want to withdraw each year or each month. They will process the withdrawal and send you the money, minus any withholding tax they are required to take out. You can change the withdrawal amount in future years if your situation changes.

Understand how withholding works and what it costs you

When you withdraw money from a 401(k), the custodian is required to withhold a percentage for federal income tax. The standard withholding rate is 20 percent for most withdrawals, though you can request a different rate. If you withdraw $10,000, the custodian will send you $8,000 and hold back $2,000 for taxes.

That $2,000 withholding is not your final tax bill — it is just a prepayment. When you file your tax return, the IRS will calculate what you actually owe based on your total income for the year. If you owe more than $2,000, you will have to pay the difference. If you owe less, you will get a refund. The withholding just determines whether you come out ahead or behind at tax time.

Many people ask the custodian to withhold zero dollars so they can keep the full amount and pay taxes later. This is legal, but it means you have to set aside the money yourself to pay the IRS when your tax return is due. If you do not have cash on hand, it is usually safer to let the custodian withhold, even though it reduces the money you receive now.

Spousal rollover: the strategy that delays taxes the longest

If you are the surviving spouse, rolling the 401(k) into your own IRA is almost always the best move for tax purposes. Here is why: you do not have to take any withdrawals until you turn 73, which could be decades away. During that time, the money stays invested and grows tax-deferred. You only pay taxes when you withdraw.

To do a spousal rollover, contact the 401(k) custodian and tell them you want to roll the account into an IRA in your name. The custodian will transfer the money directly to the IRA custodian you choose (your bank, a brokerage, or another financial institution). This is a direct transfer — the money never touches your hands, so there is no withholding and no when ready tax bill.

After the rollover is complete, the money is in your IRA and subject to your own retirement rules. You can invest it however you want, and you do not have to withdraw anything until age 73. At that point, you will have to take required minimum distributions (RMDs) each year, which are calculated based on your age and account balance. Those withdrawals are taxed as ordinary income, but you have had decades for the money to grow.

Non-spouse beneficiaries: your options when you cannot roll over

If you are not the spouse, you cannot roll the 401(k) into your own retirement account. Instead, you have two main choices: take withdrawals from the inherited 401(k) directly, or move the money to an inherited IRA (sometimes called a "beneficiary IRA" or "conduit IRA").

Taking withdrawals directly from the 401(k) is simpler — you just contact the custodian and request the amount you want. The money is sent to you, minus withholding. The downside is that you have less control over the investment of the remaining balance, and some 401(k) plans have higher fees than IRAs.

Moving the money to an inherited IRA gives you more control. You can choose how to invest the money, and you may have access to lower-cost investment options. To do this, you open an inherited IRA at a bank or brokerage and ask the 401(k) custodian to transfer the balance directly to that account. The transfer is not a rollover (you cannot roll over as a non-spouse), but it is a direct transfer, so there is no withholding and no when ready tax bill. You then take withdrawals from the inherited IRA on your schedule, as long as the account is empty by the ten-year important date.

What to do if you need the money before the important date

If you need to withdraw more than you planned in a particular year, you can. There is no penalty for taking extra money from an inherited 401(k) or inherited IRA — you just pay income tax on the withdrawal. The only rule is that the entire balance must be gone by the important date (ten years for most non-spouse beneficiaries, or age 73 for a spouse who rolled over).

If you are facing a financial emergency and need a large sum, you can withdraw it without penalty. The tax bill will be higher that year because the withdrawal is added to your other income, but there is no 10 percent early withdrawal penalty like there would be if you withdrew from your own 401(k) before age 59½. That is one small advantage of inheriting: the early withdrawal penalty does not explore.

Before you withdraw, check with a tax professional about the impact on your tax bracket for that year. If you are close to a bracket boundary, taking the money in a different year might save you money. A tax preparer can run the numbers and tell you whether it is better to withdraw now or wait.

Frequently Asked Questions

Do I have to pay taxes on an inherited 401(k) right away?

No. You only pay taxes when you withdraw money. If you leave the balance in the account, no taxes are due. However, if you are a non-spouse beneficiary, you must withdraw the entire balance by the ten-year important date, so you will eventually pay taxes on all of it.

Can I put an inherited 401(k) into my own 401(k) to avoid taxes?

Only if you are the surviving spouse. Spouses can roll an inherited 401(k) into their own IRA or 401(k). Non-spouse beneficiaries cannot do this — you must keep the money in an inherited account and follow the ten-year withdrawal rule.

What if I withdraw the whole inherited 401(k) in one year by mistake?

You will owe income tax on the full amount that year, which will likely push you into a higher tax bracket and result in a larger tax bill than if you had spread the withdrawals. You cannot undo the withdrawal, but you can plan better for future years. If you inherited multiple accounts, you might have more flexibility with the next one.

Is there a penalty for withdrawing from an inherited 401(k) before age 59½?

No. The 10 percent early withdrawal penalty that applies to your own 401(k) does not explore to inherited accounts. You only pay ordinary income tax on the withdrawal, regardless of your age.

What happens if I do not withdraw the full balance by the important date?

The IRS will impose a penalty equal to 25 percent of the amount you should have withdrawn but did not. This penalty is in addition to the income tax you owe on the withdrawal itself. It is one of the harshest penalties in the tax code, so meeting the important date is critical.