Taxes on an Inherited 401(k): Spouse and Non-Spouse Rules

Money you pull from an inherited 401(k) is taxed as ordinary income if the account was a traditional 401(k), and usually tax-free if it was a Roth. There is no 10% early withdrawal penalty regardless of your age. The size of your tax bill on an inherited 401(k) comes down to three things: whether the account was traditional or Roth, your relationship to the person who died, and how many years you spread the withdrawals across. Taking the whole balance in one year almost always costs more in tax than taking it in pieces.

Traditional vs. Roth Changes Everything

Every dollar you withdraw from an inherited traditional 401(k) counts as ordinary income on your federal return.¹ The original owner funded the account with pre-tax dollars, so neither the contributions nor the gains have ever been taxed. That entire bill now lands on you. A $200,000 balance withdrawn in one year stacks on top of your salary and any other income, and can easily push you into a higher federal bracket than you normally occupy.

An inherited Roth 401(k) works the other way. The original owner already paid income tax on the contributions, so a qualified distribution comes to you entirely tax-free, including the investment earnings.² A distribution qualifies when the deceased owner’s Roth account was open for at least five tax years before the withdrawal and the distribution is made after the owner’s death.

If the five-year clock has not finished running, the distribution is non-qualified. The contribution portion still comes to you tax-free, but the earnings portion is taxed as ordinary income.³ The five years are measured from the owner’s first Roth contribution to that plan, not from when you inherited it, so most beneficiaries of a long-held Roth 401(k) end up receiving everything tax-free.

No 10% Early Withdrawal Penalty

Beneficiaries under age 59½ do not owe the 10% early withdrawal penalty on an inherited 401(k). Federal law specifically exempts distributions made to a beneficiary after the account owner’s death.⁴ It applies whether you take a lump sum or installments, and whether you are a spouse or non-spouse.

The exemption only holds while the funds sit in an inherited account or come directly from the deceased’s plan. A surviving spouse who rolls the money into their own IRA and then takes a withdrawal before 59½ will owe the 10% penalty, because the funds are now treated as the spouse’s own retirement savings.

If You Are the Surviving Spouse

Spouses have options no other beneficiary gets, and the choice between them is a tax decision as much as a planning one.

The most powerful option is rolling the inherited 401(k) into your own IRA.¹ Once the funds are in your own account, the IRS treats them as if they were always yours. You do not need to take required minimum distributions until age 73, and the money keeps growing tax-deferred.⁵ The trade-off is the penalty exposure described above: if you are under 59½ and might need the money soon, rolling it into your own IRA costs you the beneficiary exemption.

Keeping the funds in an inherited 401(k), or moving them to an inherited IRA, preserves penalty-free access at any age. You take distributions based on your own life expectancy or the deceased’s remaining life expectancy, whichever is more favorable, and if the deceased died before their required beginning date you can delay RMDs until the year they would have turned 73.¹

A lump sum is always available but rarely tax-efficient on a traditional account. A $400,000 lump sum added to a $60,000 salary pushes your taxable income to $460,000 for the year, into brackets neither income would otherwise reach.

If You Are a Non-Spouse Beneficiary

Children, siblings, friends, and most other non-spouse beneficiaries have to empty the account by the end of the tenth calendar year after the owner’s death.¹ The SECURE Act replaced the older approach that let non-spouses stretch distributions across their own life expectancy.

How you draw the account down inside those ten years depends on when the owner died:

If the owner died before their required beginning date, you can withdraw any amount at any pace, as long as the balance is zero by December 31 of the tenth year. There are no annual minimums in years one through nine.
If the owner died on or after their required beginning date, you must take annual RMDs in years one through nine, calculated under the IRS life expectancy tables, and clear whatever remains by the end of year ten.¹

Non-spouse beneficiaries cannot roll inherited 401(k) funds into their own IRA. The only transfer option is a direct trustee-to-trustee transfer into an inherited IRA titled in the deceased’s name for your benefit, such as “Jane Smith as beneficiary of John Smith.” If the plan sends you a check instead, the full amount is taxable income for that year and cannot be rolled over.

The Exception: Eligible Designated Beneficiaries

A small group of non-spouse beneficiaries escapes the 10-year rule. The IRS calls them eligible designated beneficiaries, and the category covers:¹

Minor children of the deceased. Only the deceased’s own minor children qualify, not grandchildren, nieces, or nephews.
Disabled or chronically ill individuals, as defined under the Internal Revenue Code.
Beneficiaries not more than 10 years younger than the deceased.

These beneficiaries can stretch distributions over their own life expectancy, which keeps each year’s taxable income much smaller than the 10-year rule would. Minor children lose this status at the age of majority, defined as 21 under Treasury regulations, and the 10-year clock starts then.

Timing Withdrawals to Keep the Tax Bill Down

For most beneficiaries, timing is the main lever. On a traditional inherited 401(k) under the 10-year rule, nothing requires you to wait until year ten and take the whole balance at once, assuming the owner died before their required beginning date. Spreading withdrawals across multiple tax years keeps each year’s taxable income lower and often keeps you out of higher brackets entirely.

The practical approach is to estimate your income for each of the ten years and take larger withdrawals in the years your other income is expected to be lower. A year between jobs, a sabbatical, or early retirement is a natural year to accelerate distributions. A year with a large bonus or a stock sale is a year to take less, or nothing.

Surviving spouses who roll the money into their own traditional IRA and do not need the funds for decades benefit from continued tax-deferred growth. For spouses inheriting a Roth 401(k), moving the funds to an inherited Roth IRA preserves tax-free growth while still meeting distribution rules.

What You Will See on Paper

Every distribution generates a Form 1099-R from the plan administrator showing the gross amount, the taxable amount, and any taxes withheld.⁶ You report the income on your Form 1040 for the year you received the money. The taxable amount increases your adjusted gross income, which can also affect Medicare premium surcharges and the taxability of your Social Security benefits.

When a distribution is paid directly to you rather than moved trustee-to-trustee, the plan is generally required to withhold 20% for federal income tax. That withholding is a prepayment, not the final bill. If your actual rate is higher than 20%, you will owe more at tax time; if it is lower, you will get a refund. Either way, you receive 80% of the gross amount upfront, which catches many beneficiaries off guard when they were counting on the full figure.

Missing a Deadline Is Expensive

The IRS imposes a 25% excise tax on the shortfall between what you should have withdrawn and what you actually took.⁷ A missed $30,000 RMD alone carries a $7,500 penalty, on top of the income tax you still owe on the money once you take it.

The penalty drops to 10% if you correct the shortfall during the correction window, which generally runs until the earlier of an IRS deficiency notice or the end of the second tax year after the penalty was imposed.⁷ Catching a missed distribution quickly and taking the correct amount can save thousands.

Two Boundaries Worth Knowing

Federal rules set the maximum stretch you are allowed, but the employer’s plan document can be stricter.⁸ Some plans require non-spouse beneficiaries to take a lump sum rather than drawing the account down over ten years. Others only offer periodic installments. Call the plan administrator before you make any decisions and ask what the plan actually allows.

State tax is a separate layer. Most states with an income tax treat inherited 401(k) distributions as ordinary income the same way the federal government does. A handful of states have no income tax or exempt retirement plan distributions. Your state of residence when you receive the distribution controls, not the deceased’s state, so a recent move can change the answer.

1
Internal Revenue Service. Retirement Topics – Beneficiary
2
Internal Revenue Service. Roth Account in Your Retirement Plan
3
Internal Revenue Service. Retirement Plans FAQs on Designated Roth Accounts
4
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
5
Internal Revenue Service. Retirement Topics – Required Minimum Distributions (RMDs)
6
Internal Revenue Service. About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
7
Office of the Law Revision Counsel. 26 USC 4974 – Excise Tax on Certain Accumulations in Qualified Retirement Plans
8
Internal Revenue Service. 401(k) Resource Guide – Plan Participants – General Distribution Rules