Losing someone is hard enough. Trying to understand what to do with their retirement accounts in the middle of all that is even harder. Over the years, we’ve walked many federal families through this exact moment, and the first thing we tell them is this: you don’t have to make every decision right away.

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Key Takeaways

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• Yes, most beneficiaries do pay taxes on inherited Traditional 401(k) withdrawals.
  
  
• Your tax bill depends on your relationship, the type of 401(k), and how you time distributions.
  
  
• The 10-year rule traps many beneficiaries into paying more tax than necessary.
  
  
• Federal employees should coordinate inherited 401(k) withdrawals with FERS, TSP, Social Security, and other income streams.
  
  

Quick Answer: When Beneficiaries Pay Taxes on a 401(k)

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If you inherit a Traditional 401(k), withdrawals generally become taxable income in the year you take them.
If you inherit a Roth 401(k), the withdrawals are usually tax-free, as long as the account met the five-year requirement.

We’ve seen families breathe a sigh of relief when they learn they don’t have to cash out immediately. In fact, rushing the process is one of the biggest mistakes beneficiaries make. Taking time to understand the rules can save thousands of dollars in avoidable taxes.

Myth-busters:

• You will not pay a 10% early withdrawal penalty on inherited accounts.
  
  
• The beneficiary form overrides the will a common source of unpleasant surprises.
  
  
• Pre-tax 401(k) money is not tax-free, even though it’s inherited.
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• In our experience, simply clearing up these misconceptions helps clients make calmer, more confident decisions.

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How the IRS Classifies You And Why It Matters

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Your tax treatment depends on what type of beneficiary you are.

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1. Spouse Beneficiary

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Spouses get the widest range of choices: rollovers, inherited IRAs, or keeping the funds in the plan (if the 401(k) allows it).

We've helped many surviving spouses decide between treating the account as their own vs. keeping it as an inherited IRA. The best choice often depends on age and income especially if the spouse hasn’t reached 59½ yet.

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2. Non-Spouse Beneficiary

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Children, siblings, and others typically have fewer options and almost always fall under the 10-year withdrawal rule.

Many adult children tell us they feel pressured to “do something” right away. But the smart move is often slowing down long enough to understand how withdrawals interact with their job income, family finances, and taxes.

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3. “Eligible Designated Beneficiary” (EDB)

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EDBs—spouses, minors, disabled individuals, or someone close in age to the decedent—may use life expectancy withdrawals instead of the 10-year rule.

When we explain to clients that they can stretch distributions over decades, the relief is noticeable. Spreading the income out often keeps taxes significantly lower.

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The 10-Year Rule: The Tax Trap Most Beneficiaries Don’t See Coming

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Most beneficiaries must empty the inherited 401(k) by December 31 of the 10th year following the year of death.

Here’s the part people miss:
If the original owner had already started RMDs, you may also need annual distributions in years 1–9.

We’ve seen many beneficiaries assume they can “just wait 10 years,” only to realize they owe earlier RMDs and penalties if they miss them.

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Why this rule causes problems

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For working professionals, especially federal employees with stable salaries, a large inherited distribution can:

• Push income into a higher bracket
  
  
• Increase Medicare IRMAA premiums
  
  
• Affect Social Security taxation
  
  
• Stack on top of FERS/TSP withdrawals
  
  

When we model this out with clients, it’s common to find that spacing withdrawals over multiple years creates a dramatically smoother tax profile.

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‍Your Distribution Options and How Each Is Taxed

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1. Lump-Sum Distribution

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All taxable at once.
This option almost always produces the highest tax bill.

We’ve seen clients take lump sums before talking to us often because the paperwork made it look like the default. In most cases, spreading withdrawals would have saved thousands.

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2. Inherited IRA (the most flexible route for most beneficiaries)

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Allows you to:

• Invest the money how you prefer
  
  
• Time withdrawals strategically
  
  
• Follow either the 10-year or life-expectancy rules
  
  Most federal employees we advise choose this route because it aligns best with long-term planning and tax management.

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3. Spouse-Only: Treating the 401(k) as Your Own

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Great for long-term growth and simplicity but only if you're over 59½ or don’t need early access.

We find that younger surviving spouses often choose the inherited IRA first to preserve penalty-free access, then consider merging accounts later.

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4. Leaving Money in the 401(k)

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Whether this is allowed depends entirely on plan rules, not IRS rules.

Many beneficiaries assume they can leave funds in the plan but discover the 401(k) forces a faster withdrawal schedule. This is one of the reasons we always ask clients to review the plan’s distribution options before making any decisions.

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5. Inherited Roth 401(k)

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Tax-free withdrawals (if the 5-year rule is met), but the 10-year or life-expectancy timeline still applies.

Most beneficiaries choose to let Roth assets grow as long as possible because every year of tax-free compounding matters.

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Common Mistakes We See and How to Avoid Them

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Mistake 1: Not updating or checking beneficiary forms

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This is the #1 cause of inheritance disputes we see. A will does not override a beneficiary form.

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Mistake 2: Mixing multiple beneficiaries into one account

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Each beneficiary should have their own inherited account.
We’ve seen siblings unintentionally trigger shorter withdrawal timelines simply because the accounts weren't separated.

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Mistake 3: Taking distributions without understanding tax consequences

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We’ve had clients come to us after cashing out large accounts, not realizing the tax impact. Slowing down often prevents this.

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Mistake 4: Not coordinating with federal benefits

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Federal employees must consider how distributions interact with:

• FERS or CSRS pension income
  
  
• TSP withdrawals or RMDs
  
  
• Social Security timing
  
  
• Survivor benefits
  
  Coordinating all of these pieces can significantly reduce long-term taxes.

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A Practical 30-Day Checklist After You Inherit a 401(k)

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First Week

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• Contact the plan administrator
  
  
• Request the beneficiary packet
  
  
• Ask for the plan’s distribution options (they’re not all the same)
  
  

Clients often tell us this step alone clears up half the confusion they finally see what choices they actually have.

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First Month

• Identify whether you're a spouse, non-spouse, or EDB
  
  
• Confirm Traditional vs Roth
  
  
• Gather statements, plan rules, and deadlines
  
  

Most of our clients discover they don’t need to act as quickly as they thought, and that waiting allows for smarter tax planning.

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Before Making Any Election

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Speak with someone who understands both federal retirement systems and retirement taxation.
The interaction between 401(k)/IRA rules and federal benefits is where we see the most accidental overpayment.

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Ready to Make the Right Decision About Your Inherited 401(k)?

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At Federal Pension Advisors, we’ve helped countless federal employees and their families navigate the confusing mix of 401(k) rules, TSP options, survivor benefits, and tax decisions that come with inheriting retirement accounts.

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Most people don’t realize how much tax they can avoid or how many mistakes they can prevent until someone walks them through the numbers step by step. That’s where we come in.

If you’d like clarity on:

• How to minimize taxes over the 10-year window
• How inherited accounts impact your FERS, TSP, and Social Security strategy
• Whether to roll over, withdraw, or leave money in place
• How to protect your own heirs from unnecessary taxes

We’re here to help you make smart, confident decisions.

Get Personalized Guidance At No Cost

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You can schedule a Free Consultation directly through our website:

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FAQ:

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How are 401(k) beneficiaries taxed?

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Traditional 401(k) withdrawals are taxed as ordinary income.
Roth 401(k) withdrawals are tax-free if the account met the five-year rule.

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Do I have to pay taxes on money I receive as a beneficiary?

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Yes if it comes from a Traditional 401(k), you’ll owe income tax when you take withdrawals.
Roth accounts are typically tax-free.

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What is the 5-year rule for 401(k) beneficiaries?

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For Roth 401(k)s, the account must be open 5 years for withdrawals to be tax-free.
(This rule is about taxes not distribution timing.)

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Does a beneficiary have to pay taxes on a retirement account?

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Yes, on Traditional retirement accounts.
No, on Roth accounts (if requirements are met).

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Disclaimer: This information is for educational purposes only and is not tax, legal, or financial advice. Always consult a qualified professional before taking action on inherited retirement accounts.

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Content References

• IRS – Retirement Topics: Beneficiaries
• IRS Publication 590-B – Distributions from IRAs
• IRS Roth 5-Year Rule Guidance
• SECURE Act & SECURE 2.0 Summaries (Congressional updates)
• Major 401(k) Plan Administrator Guides (Fidelity, Vanguard, TSP)

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