Maybe you are designated as a beneficiary of a 401(k) plan and want to know more about 401(k) distribution rules so you can choose the best payment option for your needs.
Maybe a designated 401(k) beneficiary used unlawful means in order to receive a 401(k) inheritance, and as an heir of the deceased, you are wondering whether the 401(k) beneficiary designation can be contested.
Maybe there was no beneficiary on a 401(k) plan or the beneficiary that was designated died before they were able to claim their 401(k) inheritance.
There are many complicated scenarios that can arise in the context of inherited 401(k) plans, but by learning the ins and outs of inheriting a 401(k), as well as the circumstances under which 401(k) beneficiaries can be contested, you will be equipped to handle any challenge that comes your way.
What Is a 401(k) Plan?
If you work for a U.S.-based employer, you might already know about 401(k) plans or even have one yourself. For those unfamiliar with 401(k)s, they are retirement savings plans that enable employees to deposit a portion of their pre-tax salary into an investment account. The funds in this account can be used to invest in various financial assets, such as stocks, bonds and mutual funds, with the aim of growing the savings over time.
Because contributions to 401(k) plans are made with pre-tax dollars, they defer the account holder’s tax obligations until they or their 401(k) beneficiary withdraws funds from the account. Unless their financial needs call for it, most 401(k) account holders will not withdraw funds from their account until age 59½, as that is when they can withdraw funds without encountering penalties.
Upon opening a 401(k) account or at some point after, account holders may designate a beneficiary to inherit the account in the event they die with money still remaining in it.
How is a 401(k) paid out after death? How long does it take to get a 401(k) inheritance? Can a beneficiary cash out a 401(k)? The answers to these questions usually depend on the beneficiary’s relation to the decedent, as well as on the 401(k) distribution rules that apply to them.
Continue reading to learn more about 401(k) beneficiaries.
What Is a 401(k) Beneficiary?
A 401(k) beneficiary is a person or entity whom the 401(k) account holder designates to inherit either the entirety of their 401(k) account or a portion of it. Account holders are permitted to designate as many 401(k) beneficiaries as they would like, as well as specify the exact amount or percentage they wish for the beneficiary to inherit.
When the beneficiary designation on a 401(k) account is an individual person, account assets generally can transfer directly to that person upon the account holder’s death without having to pass through the probate process.
On the other hand, if the beneficiary designation on a 401(k) account is an estate, account assets will be subject to the probate process and potentially even be distributed to creditors by the executor/administrator to pay off the decedent’s debts. If the beneficiary designation on a 401(k) is a trust, account assets generally won’t have to pass through probate, but they still could be used to pay off the trust’s or account holder’s debts.
What Is a Primary Beneficiary for a 401(k)?
Whoever is designated to inherit a 401(k) upon the account holder’s death is called the primary beneficiary. The primary beneficiary on a decedent’s 401(k) will typically be their surviving spouse (if they had one).
Keep in mind that more than one person can be named as a primary beneficiary of a 401(k).
What Is a Contingent Beneficiary for a 401(k)?
When a primary beneficiary predeceases a 401(k) account holder, can’t be located, or waives their right to a 401(k) inheritance, the account generally will pass to the contingent beneficiary, who essentially is a backup beneficiary.
It is standard for account holders to designate one or more contingent beneficiaries when designating a primary beneficiary.
401(k) Beneficiary Rules After Death of Account Holder
Inheriting a 401(k) isn’t always a straightforward process, as 401(k) beneficiary rules vary based on whether or not the beneficiary was the account holder’s spouse. Specifically, the options that are available to you for managing the money you’ve inherited, as well as the impact on your taxes, will depend on your relation to the original account holder.
It’s likely you’ll also be subject to different 401(k) beneficiary rules if you are a minor child of the account holder, fewer than 10 years younger than the account holder or are disabled or chronically ill.
Inherited 401(k) From Spouse
If your spouse died with a 401(k) account, you likely are wondering: Is a spouse automatically the beneficiary of a 401(k)? The answer to your question is yes. Let us explain.
Federal law requires for the 401(k) accounts of married account holders to transfer to their surviving spouse upon their death without exception. If, for any reason, the account holder wishes for their 401(k) assets to transfer to someone other than their spouse, their spouse will need to sign a waiver for a non-spouse beneficiary to be valid.
As for the 401(k) beneficiary rules surviving spouses will be subject to, they will mostly come into play when you are taking 401(k) distributions. You should take time to select the best distribution option for your needs and financial situation.
401k distribution options for surviving spouses include:
- Taking a lump-sum 401(k) distribution: With this option, you will not incur any penalties for an early withdrawal of funds; however, the distribution will be taxed as regular income, so it has the potential to kick you up to a higher tax bracket.
- Roll over the inherited 401(k) into your own 401(k) or IRA account: This is a good option if you would prefer to further grow the inherited 401(k) assets. Keep in mind that if you make withdrawals before reaching age 59½, you likely will face penalties.
- Roll over the inherited 401(k) into a new inherited IRA: This option will allow you to withdraw funds without facing penalties, even if you are younger than 59½.
- Leave deceased spouse’s 401(k) plan intact: This option allows you to make withdrawals of funds over time so your tax obligations remain minimal. If your spouse had been receiving 401(k) distributions when they died, you will have the option to continue these payments.
While the list above can help you get an idea of 401(k) distribution rules for spouses, it is by no means comprehensive, as 401(k) distribution rules are complex and there are many factors that could affect them. Before making any decisions surrounding your inherited 401(k), it is crucial you consult with a financial adviser.
Inherited 401(k) From Parent
If a 401(k) account holder died without a spouse, or their spouse predeceased them, they may have designated one or more of their children as beneficiaries.
What are the 401(k) beneficiary rules for a surviving child? Are they the same as 401(k) spouse beneficiary rules? Can a minor be a beneficiary of a 401(k)? These are great questions to ask if you are inheriting a 401(k) from a parent.
When anyone other than a 401(k) account holder’s spouse inherits a 401(k), they are required to take the money within 10 years. They can make withdrawals over time, but the account must be depleted within a 10-year timeframe.
If you’ve inherited a 401(k) from a parent, keep in mind that any withdrawals you make from the account will be taxed as regular income, so while you can take a lump-sum distribution, doing so could result in higher taxes for that year and may even cause you to be placed in a higher tax bracket.
As to whether a minor can be named as a 401(k) beneficiary, there is nothing in the law that forbids it. However, minors generally will not be able to access the 401(k) funds until they reach the age of majority, which is 18 in California. In order to access funds prior to the minor turning 18, a guardian of the estate may need to be appointed for the minor, or a trust may need to be set up to allow a trustee to manage the funds until the minor comes of age.
Inherited 401(k) From Non-Spouse
When a non-spouse inherits a 401(k), they also will be subject to the 10-year rule. In other words, they will be required to withdraw the entirety of the 401(k) account within 10 years from the account holder’s death and pay taxes on it.
Non-spouse beneficiaries will have the option to withdraw all the funds at once or make withdrawals over time (but within 10 years). The latter option can help keep the beneficiary’s annual tax obligations minimal.
The only exceptions to the 10-year rule are if the non-spouse beneficiary on the 401(k) is fewer than 10 years younger than the decedent, or is chronically ill or disabled. In these instances, beneficiaries will have the option to withdraw funds over the course of their lifetime.
No Beneficiary on 401(k)
When a 401(k) account holder dies without having designated a beneficiary to inherit the account, it will still pass to their surviving spouse (if they had one). If the account holder did not have a surviving spouse, it’s possible the account will pass to their children, but whether this happens will depend on the specific terms of their 401(k) plan.
If the account holder did not have a spouse or children, or if the terms of the 401(k) don’t provide for their children to automatically inherit their account, the account likely will pass to the account holder’s estate, where it will be distributed by the personal representative in accordance with the terms of their will or intestate succession laws.
Note that a 401k death distribution to an estate is not protected from the reach of creditors in the same way beneficiary designations are. If a decedent had owed debts when they died, the proceeds from the 401(k) could potentially be used to pay them off.
Can You Contest a 401(k) Beneficiary?
As with other types of beneficiary designations (e.g., annuity beneficiaries, bank account beneficiaries and life insurance beneficiaries), a 401(k) beneficiary can be contested for certain reasons.
Grounds for Contesting a 401(k) Beneficiary
The grounds for contesting a 401(k) beneficiary are similar to the grounds for contesting a will or trust.
Valid grounds for contesting a 401(k) beneficiary include:
- Fraud: The 401(k) beneficiary engaged in deceit or misled the account holder in order to be designated.
- Forgery: The 401(k) beneficiary falsified the account holder’s signature on 401(k) documents.
- Undue Influence: The 401(k) beneficiary applied extreme pressure on the account holder in order to convince the account holder to designate them as a beneficiary.
- Improper Execution: The account holder failed to designate the 401(k) beneficiary using the methods outlined in the 401(k) contract.
- Lack of Capacity: The account holder designated, changed or revoked a 401(k) beneficiary when they were not of sound mind and lacked the capacity to contract.
- Mistake: The account holder designated, changed or revoked a 401(k) beneficiary by mistake.
Keep in mind that you will need evidence to contest a 401(k) beneficiary based on one or more of the grounds mentioned above. A probate attorney can assist with gathering this evidence, filing the necessary petitions, and arguing your case in court.
Beneficiary designations can be difficult to contest since they either are payable-on-death or transfer-on-death assets. For example, if a 401(k) beneficiary takes a lump-sum payout from a decedent’s 401(k) shortly after their death, recouping the inheritance could be a challenge, though it is not impossible. This is why it’s crucial for you to not only work with a skilled attorney, but to bring your contest without delay (preferably before any distributions of the 401(k) are made).
Does a Will Override a Beneficiary on a 401(k)?
A 401(k) account holder’s will does not override a 401(k) beneficiary designation. When establishing 401(k), account holders fill out a form to designate beneficiaries. If they need to make changes to their 401(k) beneficiaries, they do so by filling out a new beneficiary designation form.
Some 401(k) account holders falsely believe that they can simply include a provision in their will if they want to change the beneficiaries on their 401(k) account; however, their will won’t supersede their original beneficiary designations unless they are successfully contested.
Likewise, if the 401(k) account holder died with a surviving spouse, they will inherit the 401(k), regardless of the terms of the account holder’s will or whom they designated as beneficiaries (the only exception being if the spouse waived their 401(k) inheritance rights).
Does a Trust Override a Beneficiary on a 401(k)?
Beneficiary designations are made via a 401(k) contract, so in order for them to be changed, the contract will also have to be changed. A decedent including a provision in their trust to that effect typically will not suffice, though it could lead to a legal dispute concerning entitlement to the death benefits associated with the 401(k) plan.
That said, a 401(k) account holder can designate their trust as the beneficiary of their 401(k), as long as they do not have a spouse, but doing so could potentially lead to the funds in the account being used to pay trust administration costs or creditors.
Have questions about contesting a 401(k) beneficiary? We can help.
Contesting a 401(k) beneficiary is no easy feat, but by having a knowledgeable probate firm in your corner, your chances of success can greatly improve.
Not only can your team of attorneys investigate the matter at hand to come up with a winning game plan, but they can answer any questions you have along the way.
Request a free consultation with us today to learn how we can help.
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The post Guide to Inherited 401(k) Plans & Contesting Beneficiaries appeared first on Keystone Law.
