Somebody will get your 401k when you die. That person (or persons) is called the beneficiary.
If you’ve chosen your spouse as your beneficiary, or if you named no other beneficiary and thus your 401k passed to your spouse automatically, then he or she gets the 401k with all of the tax advantages intact.
The federal government sets some of the rules for your 401k plan, but your employer writes more specific rules that fit within the IRS guidelines. That means you may or may not receive all of the nice advantages the IRS allows. For example, while the IRS may allow spouses to keep their money in 401k plans for a while, your specific plan may not. Your plan might say to the grieving widow, “Take your money and go.” Make certain that you read the paperwork for your own 401k plan.
Your beneficiary will be able to roll the funds over into an Individual Retirement Account. (This is a recent change, and you may find older references which say that only the spouse can roll over into a 401k. That is no longer the case.) This is great, because it defers the tax bill until the beneficiary actually withdraws money. The beneficiary should read both Chapter 6 on Rollovers and the plan documents. Then he or she should select a good company to provide the IRA, and let that company handle the rollover. The surviving spouse should not take the cash and then move it into an IRA.
Beneficiaries who don't roll the 401k over into an IRA should check the plan’s rules because the plan, may allow for payments over time. This will spread out the tax bill over many years and thereby allow the money to continue to grow with tax deferral. Even though the IRS allows distributions to beneficiaries over a period of years, many plans do not. Because of the administrative costs, those employers don’t want to be bothered making payments over a number of years. They may require the beneficiary to take the cash in a lump sum.
There are two possible cases: Your 401k goes to your spouse or it passes to someone else.
If you’ve chosen your spouse as your beneficiary, or if you named no other beneficiary and thus your 401k passed to your spouse automatically, then he or she gets the 401k with all of the tax advantages intact.
The federal government sets some of the rules for your 401k plan, but your employer writes more specific rules that fit within the IRS guidelines. That means you may or may not receive all of the nice advantages the IRS allows. For example, while the IRS may allow spouses to keep their money in 401k plans for a while, your specific plan may not. Your plan might say to the grieving widow, “Take your money and go.” Make certain that you read the paperwork for your own 401k plan.
If your spouse is the one getting the money, he or she will be able to roll the funds over into an Individual Retirement Account. This is great, because it defers the tax bill until the spouse actually withdraws money. Although the spouse will have to withdraw money according to a different minimum distribution schedule than what a couple uses, that is really only a minor issue. If this happens, the surviving spouse should read both Chapter 6 on Rollovers and the plan documents. Then he or she should select a good company to provide the IRA, and let that company handle the rollover. The surviving spouse should not take the cash and then move it into an IRA.
For beneficiaries who are not the spouse, such as sons or daughters, it’s even more important to check the plan’s rules because such beneficiaries cannot roll the 401k money over into an IRA. The plan, however, may allow for payments over time. This will spread out the tax bill over many years and thereby allow the money to continue to grow with tax deferral. Even though the IRS allows distributions to beneficiaries over a period of years, many plans do not. Because of the administrative costs, those employers don’t want to be bothered making payments over a number of years. They may require the beneficiary to take the cash in a lump sum.
This is another good reason for a retired person to roll the 401k into an IRA. Then there’s no doubt that the beneficiaries can take the money out on a long schedule, over as many years as the IRS allows.
The important lesson here is simple: your 401k may be a joint asset. Don’t think of it as “mine,” think of it as “ours.” Divorce law varies from state to state, so you’ll need to check with a good attorney in your jurisdiction. You may be able to keep the amount you had before the marriage, but you will likely have to split the 401k assets that accumulated during the marriage.
Your particular 401k plan may limit your choices for distributing the spouse’s portion. As in death, the plan administrator may not want the bother of keeping two accounts open. Check the details of your particular plan before you start negotiating.
The mechanics of splitting a 401k are pretty flexible. You might keep sole title to your 401k while your spouse keeps other assets, such as the house. Or you might split the 401k down the middle. You and your spouse can negotiate pretty much anything you want. The result will be a “Qualified Domestic Relations Order,” the legal document that allows your spouse to have a portion of your 401k. (Your attorney may pronounce it “quadro.”) If there is a loan from the 401k outstanding, be sure that repayment of the loan is specifically addressed.
There is no penalty tax when a 401k is split up (whether split 50-50 or in other proportions) so long as the Qualified Domestic Relations Order is properly prepared and the spouse transfers the money into a new 401k account or rolls it directly into an IRA. Be careful not to take a check from the plan and deposit it to your own bank account. It’s safest to have the money transferred directly into a new 401k account or an IRA (which can be a new IRA or an existing IRA).
After the divorce—by which I mean within 5 minutes after the divorce is finalized—change the beneficiary of your 401k. Have the paperwork prepared ahead of time and ready to sign.
Bill Says: This is NOT the time to be stingy with lawyer’s fees. Get advice from someone who handles this sort of thing every day.
The key steps for managing your 401k in a divorce are:
Disclose information about your plan to your attorney, including your account balance and the plan’s rules for distributions in case of divorce.
Make sure the Qualified Domestic Relations Order is followed by the 401k plan administrator. Don’t let anybody drop the ball.
Change your beneficiary after the divorce is final.
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Drill Down: Who Gets Your 401k When You Die
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