Must 401(k) plan beneficiaries pay income tax on withdrawals?

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Question:

I have a 401(k) plan that's worth about $50,000. Will my beneficiaries have to pay taxes or penalties if they withdraw this money when they inherit it after my death? Can they roll it over into another tax-deferred plan?

Answer:

Assets in a 401(k) plan are taxed whenever the money comes out of the plan. If you take it out during your lifetime, you will pay income tax on the amount you withdraw each year. If there is money left when you die, your beneficiaries must pay income tax on it as it comes out of the plan.

Only a surviving spouse can roll over your retirement plan into another retirement plan of his or her own when you die. Other beneficiaries are required to start taking distributions in the year after your death. (Though if you had already begun taking required minimum distributions, they must take out the required minimum in the year of your death.) As long as your beneficiaries withdraw the minimum required amount -- a sum that is computed according to a prescribed formula -- there will be no penalties, just income tax.

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