This article will discuss what happens to your 401k and other retirement accounts when you die. I’ll also explain some of the basics of estate planning and why it is imperative to regularly review your beneficiaries and your financial planning process.
So, what happens to your 401k when you die? The account sits with your plan administrator until they receive a copy of the death benefit. From that point, the 401k will then go to your beneficiary if you have one elected. If not, then it will be paid out to your estate.
In this article, we are going to discuss a few different things:
- What Happens to your 401k When you Die
- Your Options When Receiving an Inherited 401k
- When to Review Your Beneficiaries
- What Happens to Other Retirement Accounts When you Die
- The Importance of Updating Your Beneficiaries
- The Importance of Life Insurance and Estate Planning
- Wrap Up
What Happens to your 401k When you Die
Whether you’ve recently inherited a 401k or IRA or you are handling some financial planning to keep your assets safe. It is crucial to know what happens to your 401k when you pass on. When you initially set up your 401(k) with your company, you would have designated a beneficiary. If you are married, this would most likely be your spouse. If you were single, this could have been your children, family members, friends, or even a charity.
- Primary Beneficiary – This individual is the one that will receive the proceeds upon your death, so long as they are still living. This can be a sole beneficiary or split between many people.
- Contingent Beneficiary – This individual receives a payout if the Primary individual has already passed on by the time you pass away.
These are important to note on any policy that you own. You want to keep a list of your primary and contingent beneficiaries and update them during any significant life event.
Remember, if you don’t know who your beneficiaries are, reach out to your plan sponsor, and they can help you get set up with it.
Your Options When Receiving an Inherited 401k
Before you receive an inherited 401k, there are a few things to consider before you get started.
- How much is in the 401k
- You and the previous owner’s relationship
- How long ago the account owner died
- The age disparity between you and the account owner (10 years or more)
- What a 401k plan allows to be done
When we look at these different aspects, each of these has an essential part in your decision-making process. A 401k falls under federal law, specifically the Employee Retirement Income Security Act of 1974. This is more commonly known as ERISA.
Spouse – Survivor Benefits
This is important because if you are married, your spouse is typically the automatic beneficiary of a retirement plan. If you want to designate a different beneficiary, you would need the consent of your spouse. If you want to learn more, take a look here.
This is also not legal advice. If you have any questions about this, please speak with your lawyer and financial advisor.
As a spouse, you have the right to take ownership of the 401k and place it in your own IRA. You also have the option of leaving the 401k where it is and becoming the new owner. One thing to note here is that if you and your spouse are over 72 at the time of their death, you will have to take the required minimum distributions.
If you are over the age of 59 ½ and your spouse is over the age of 72, you will still be required to take the required minimum distribution. If your deceased spouse was younger than 72 at death, you could leave the assets alone, but you no longer pay a 10% early withdrawal penalty if you would like to access the funds. This now becomes part of your own retirement benefits if you leave it where it’s at.
Another option that is available to you is a lump sum payout. This means that you can take a full distribution of the 401k. Remember, this could leave you with a tax liability and significantly increase your income taxes, so speak with a tax advisor.
Unmarried
If you are unmarried, this gives you the option to designate anyone as your beneficiary without the need for signed documentation. Your beneficiary could include your mother, father, child, relative, or a charity.
If you don’t declare a beneficiary, the assets in your 401k become a part of your estate. Unless your estate is worth more than $11.7 million in 2021, you will not need to pay any estate taxes. Again, to learn more about your own situation, speak to an estate planning attorney as these laws are subject to change.
There is one last thing to mention. If you end up getting married at some point, most states will automatically override your previous beneficiary designation. Still, it is always good to update your beneficiaries during any major life event.
These individuals typically have the option of getting their assets as an Inherited IRA. A portion of all income taken will be subject to federal income tax and be considered taxable income. Suppose you decide to move it into an inherited IRA, though. In that case, you will maintain control of the retirement funds and open up an investment account.
This means your assets will be able to hold most types of investments, such as mutual funds, stocks, or bonds, or even real estate if you prefer!
Minor Children as Beneficiaries
Suppose you’ve designated your children as your beneficiaries, and they are minors. In that case, you may want to consult with an estate attorney. 401k’s can not move directly to a minor child. As such, they may get a court order to appoint a guardian or a trustee over their wealth until they reach the age of majority in their state.
Unless your child is great with money, this is usually a bad idea anyway. A great alternative here is to create a revocable trust. By putting the assets in a trust, you can protect the assets. This protects the child from spending all of the money at once. It also gives you the ability to control how much of the assets are accessed and how they are invested.
Options Available to Inheritors
- Can move assets into own 401k or a spousal IRA (Spouse only)
- Lump-Sum Distribution
- Move into an inherited Individual Retirement Account (IRA)
- Withdraw all funds within 5 years of death (2020 or before)
- Withdraw all funds within 10 years (2021 or after) (Also the 10-year rule)
- Annuitize your payment over your lifetime
When to Review Your Beneficiaries
If you haven’t taken a look at who the beneficiary is on your account recently, start now by figuring out who your beneficiaries are and if you need to make any changes. The reason is that life happens. Over a year or two, you could get married, divorced, have a child, or a multitude of other life events. You must keep everything up to date.
So, what major life events should you pause and review your beneficiaries?
- You get married
- Birth of a Child
- Divorce
- New Job
- Establish a trust
- You change your financial advisor
- There is a death in the family
These are all great moments to pause and take a look at your beneficiaries.
The first thing you want to do when you sit down with your spouse or partner is to get copies of all of your investments. You will also want to grab any life insurance policies that you have. You will want to have all of your accounts logins so that you can jot them down and keep them in one place that is both safe and secure.
Know who your Beneficiaries Are
The reason that this is important is so you can both decide how you would like to proceed. For each of these accounts, you need to know who the Primary Beneficiary is. It also helps to see if you have any Contingent Beneficiary listed on the policies as well.
Typically, the beneficiary is your surviving spouse. In many states, this is the default. Let’s try to save you time and stress and make sure that your current spouse is your primary beneficiary. This is especially important if you have gone through a divorce.
I spent ten years working as a wholesaler in the life insurance industry. I have heard horror stories of new spouses left with nothing because a husband never updated the beneficiary on an old life insurance policy. Take time to review all of them. You’ll thank yourself for it later.
When you start diving into these various accounts, you will find out who your designated beneficiary is. It may also show as a named beneficiary on some accounts. Suppose this individual isn’t who you want to receive the assets in the event something happens. In that case, you will want to get a copy of a beneficiary form.
The beneficiary form will give you beneficiary designations, so you will want to add in a primary beneficiary. If you have a spouse and children, it is good to set both a primary and contingent beneficiary.
What Happens to Other Retirement Accounts When you Die
Similar to a 401k, you want to take a look at any IRAs that you have. If you’re married, your spouse can shift those assets into a spousal IRA. If you’re not, the individual who inherits them will go into an inherited IRA. These work similar to what we spoke about above.
The Importance of Updating Your Beneficiaries
The reason that it is essential to update your beneficiaries is that your life changes. Imagine how many things have changed in the past five years. Whether you get married, divorced, have a child, or your circumstances change, you need to make sure that everything is up to date so your family is cared for.
Also, while you’re updating the beneficiaries, you want to keep everything in one place. Suppose you have a will, life insurance, various investments, and disability insurance. In that case, it is good to make sure that you store all of these documents in the same place. It is also beneficial to add in the point of contact for each policy.
If something happens to you, this makes it easy for the individual handling your estate to take care of everything. This way, all of your personal information is in one place, and all of the right people are easily accessible.
The Importance of Life Insurance and Estate Planning
Life insurance can have a significant impact on Estate Planning. Suppose you have more than $11.7 Million in net worth. In that case, your beneficiaries can get dinged for a tremendous amount of money when that wealth transitions.
One way to counter this is to work with your financial advisor or estate attorney. This is where a GUL (Guaranteed Universal Life) policy or an IUL can come into play. You can use the death benefit from these life insurance policies, which pay out tax-free to the beneficiaries, to cover your estate tax bill.
This isn’t the only way to help you concerning tax issues, but it is one of the best. This can also be a good option for individuals that want to leave a legacy for their families.
Wrap Up
We’ve talked about a lot of different things here. We discussed what happens to your 401k when you die. Don’t stress. It will go to someone, so just make sure to designate a beneficiary. There are a few different options available to you if you’re the spouse of someone recently deceased.
Make sure that you know your options before you make any decisions on a payout. Also, make sure that all of your personal information is in one place and whoever may oversee your estate knows where to find it. There is nothing more painful than a family member losing someone they love, and they don’t know where to start.
I hope this information was helpful. If you have anything, you would like me to discuss, leave it in the comments below, and thank you for reading!
Stay Happy!