Many workers contribute to 401k plans to save for retirement. When they die, they are allowed to bequeath any of the leftover funds to heirs. There is technically no limit to the amount of money you might inherit in a 401k, but there are things that can deplete the funds. Understand the rules to learn how much you might really inherit.
The Leftover Amount
Your father may have bragged about retiring with "over a million dollars" but this doesn't necessarily mean that there's still this much money available in the account. From the time he retired to the time he died, he likely took regular withdrawals to supplement Social Security or pension payments. He may also have used the funds to buy a new retirement home or to cover the increasingly expensive medical costs in old age. These expenses may have taken a big bite out of the original amount.
The deceased may have specified that any money left in the estate be distributed to a certain number of heirs. For example, if you have two siblings, it's possible that you'll have to split the amount in the 401k three ways.
One option that you have when inheriting a 401k is to close the account and receive the full amount as a lump-sum payment. Since the government has not yet received the tax payment on this money, you can expect to pay taxes on the lump sum at your current income tax level. A large amount of money may put you into a much higher tax bracket. The custodian will withhold 20 percent of the lump-sum amount, but you may have to pay more at tax time.
Spreading It Out
If you're concerned about the amount of taxes you'll have to pay on a lump-sum payment, you can spread those taxes out by rolling the amount over into an inherited IRA and taking yearly distributions based on your current life expectancy. This reduces the amount of taxes that you'll pay at one time, but it limits the amount of money you can receive from the account annually.
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