By Kevin Luu, Co-Founder and Chief Learning Officer. Reviewed on 2026-09-30.
An inherited 401(k) is not hit by an “inheritance tax” when you receive it, but every dollar you take out of a traditional (pre-tax) 401(k) is taxed as ordinary income in the year you withdraw it. Inherited Roth 401(k) money is usually tax-free. Most adult children who inherit must empty the account by the end of the 10th year after the year of death, so the real question is not whether you pay tax, but in which years and at what rate.
For a California household already earning $900,000, that rate is close to the top of both the federal and state schedules. That changes which strategies are worth the effort, and it is why the “just spread it over ten years” advice found on most sites saves this reader far less than it promises.
Income tax versus estate tax: two different bills
People searching “401k inheritance tax” usually mix up two separate taxes.
- Income tax, paid by you, the beneficiary. The deceased never paid income tax on pre-tax 401(k) money, so you do as you withdraw it. The IRS calls this income in respect of a decedent. Unlike an inherited house or brokerage account, a 401(k) gets no step-up in basis. The IRS beneficiary page is direct: beneficiaries must include taxable distributions in gross income.
- Estate tax, paid by the deceased person’s estate. The 401(k) balance counts toward the estate. For 2026 the federal basic exclusion is $15,000,000 per person (IRS), so most estates owe nothing federally. Washington is different: its estate tax applies above $3,076,000 for deaths from January 1 to June 30, 2026 and $3,000,000 for deaths from July 1 to December 31, 2026 (WA DOR). California has no estate tax for deaths after 2004 (State Controller).
If both taxes hit the same dollars (estate tax on the balance, then your income tax on the withdrawal), you may be able to deduct the federal estate tax attributable to that income on your own return. IRS Publication 559 explains the calculation. Ask the estate’s preparer for the numbers before you file.
One more relief: the 10% early withdrawal tax does not apply to distributions paid because of the owner’s death, even if you are under 59½ (IRS exceptions list). Distributions from qualified plans are also not net investment income, so the 3.8% NIIT does not apply to them (IRS NIIT page).
The 10-year rule and the annual withdrawals people miss
For deaths after 2019, most non-spouse beneficiaries must empty the account by December 31 of the 10th year after the year of death. A spouse, a minor child of the account owner, a disabled or chronically ill person, and anyone not more than 10 years younger than the owner are “eligible designated beneficiaries” with more flexible options (IRS). An adult child is not on that list.
The detail many heirs miss: if your parent had already reached their required beginning date for RMDs (generally April 1 after the year they turn 73; for a 401(k), a participant who is not a 5% owner can delay until the year they retire), you must also take an annual RMD in years 1 through 9, then empty the rest by year 10. The IRS waived penalties for missed annual amounts from 2021 through 2024; the final regulations apply from 2025 (IRS Notice 2024-35). A missed RMD now carries a 25% excise tax, cut to 10% if corrected within two years (IRS RMD FAQs).
Your practical options as a non-spouse beneficiary are usually three: take a lump sum, leave the money in the plan as a beneficiary account if the plan allows, or move it by direct trustee-to-trustee transfer into an inherited IRA, which typically gives you more investment choice and control over timing. Do not have the plan cut you a check intending to redeposit it: a non-spouse beneficiary cannot do a 60-day rollover (IRS Pub 575).
Worked example: a $600,000 inherited 401(k) in a $900,000 California household
Assumptions (illustrative): Priya, 41, is a scientist at a Bay Area biotech; her spouse is a physician. They file jointly with about $850,000 of taxable income. Priya’s father dies in 2026 at 78, past his required beginning date, leaving her a $600,000 traditional 401(k). Federal figures use 2026 brackets; California uses the 2025 schedule because 2026 California brackets are not yet published. Growth is ignored to keep the comparison clean.
| Strategy | Federal tax | California tax | Total |
|---|---|---|---|
| Lump sum in one year ($600,000) | $222,000 (all at 37%) | about $71,900 | about $293,900 |
| Ten equal withdrawals ($60,000 a year) | $222,000 (still all at 37%) | about $63,600 | about $285,600 |
| Same money moved into lower-income years (see below) | lower | lower | depends on the gap year |
Why the numbers look like this. The federal 37% bracket for joint filers starts at $768,700 of taxable income for 2026, so every extra dollar Priya withdraws is taxed at 37% whether she takes it in one year or ten. In California, the lump sum pushes most of it into the 11.3% bracket (above $891,542 for 2025) and adds the 1% Behavioral Health Services Tax on taxable income over $1,000,000. Spreading it out avoids that 1% surcharge entirely and keeps more of the money in the 10.3% bracket, saving about $8,200 out of a $600,000 inheritance. Spreading still matters (it also keeps the money growing tax-deferred longer), but it is not the big lever for this family.
The bigger lever is a low-income year. Suppose one spouse takes a year off between roles or a long parental leave, and the family’s taxable income drops to $400,000. Withdrawing $200,000 that year fills the 24%, 32% and 35% brackets for about $66,300 of federal tax instead of $74,000 at 37%, and California taxes it at 9.3% instead of the 10.3% and 11.3% it would face on top of a normal $850,000 year. That is roughly $11,200 saved on $200,000, more than the full ten-year spreading plan saves on $600,000.
Because of the annual RMD rule, Priya cannot defer everything to year 10 anyway. A sensible plan takes the required minimum each year, then moves extra withdrawals into any year that income is expected to drop.
How it plays out in Washington, and what moving does
A Seattle household in the same position pays the same $222,000 federally on a lump sum and, in 2026, no state income tax. Washington’s capital gains tax does not apply to retirement accounts. One date matters: Washington has enacted a 9.9% income tax on individual and joint AGI over $1,000,000 starting January 1, 2028 (WA DOR). DOR has not yet published how the income definition works, so a Washington family with a large inherited balance and income near $1,000,000 may want to model withdrawals in 2026 and 2027 before that tax starts.
For California families thinking about a move: federal law bars a state from taxing retirement income, including distributions from a 401(k) plan, of someone who is not a resident of that state (4 U.S.C. §114). Withdrawals taken after a genuine change of residency to Washington are outside California’s reach. Withdrawals taken while still a California resident are not.
Inherited Roth 401(k): usually tax-free, still on a clock
Distributions from an inherited Roth 401(k) are tax-free if the account met the five-year rule. If it did not, only the earnings share of each distribution, figured pro rata against contributions, is taxable (IRS designated Roth FAQs). The 10-year deadline still applies to a non-spouse beneficiary. For a high earner, the usual move is the opposite of the traditional account: leave the Roth money invested as long as the rules allow and take it near the end of year 10, since the growth is tax-free.
When your child is the beneficiary
Grandparents often name grandchildren directly. That creates three issues parents should know about.
- The 10-year rule applies from day one. The minor-child exception covers only the account owner’s own child. A grandchild is not an eligible designated beneficiary on that basis (only disability, chronic illness or being not more than 10 years younger could qualify them).
- Kiddie tax. Withdrawals are unearned income to the child. For 2026, a child’s unearned income above $2,700 is taxed at the parents’ rate (Rev. Proc. 2025-32), which for this reader is usually 35% or 37% federally. See our note on UTMA withdrawal tax rules for how the same rule works on custodial accounts.
- A minor cannot manage the account. Without a trust or custodian named on the form, a court guardianship of the estate may be needed to control it.
For your own 401(k), your minor child is an eligible designated beneficiary until age 21, then the 10-year rule starts, so the account must be empty by the end of the year the child turns 31. Naming a properly drafted trust as beneficiary (with your spouse’s written consent if you are naming someone other than your spouse) is how most families control when a 25-year-old actually gets the money. That decision belongs with your estate planning documents, not on a benefits website at 11 p.m.
What to write down for your kids
An inherited 401(k) is one of the clearest examples of money arriving without the reasoning behind it. Your father saved it for decades. Your children will see you spend, invest or give it, but not why. Write a one-page note: what the account was, what you decided (lump sum, spread, timed to a low-income year), the tax cost, and what you would do differently. As Kevin Luu puts it: “Your kids don’t need to inherit your portfolio. They need to inherit your decision-making process.” Our family governance work is built around exactly that kind of record.
Common mistakes
- Cashing out in year one “to simplify” and pushing most of it into California’s 11.3% bracket, plus the 1% surcharge on taxable income over $1,000,000.
- Skipping the annual RMD when the parent died after their required beginning date.
- Taking a check instead of a direct transfer to an inherited IRA.
- Leaving grandchildren as direct beneficiaries with no trust or custodian.
- Assuming Washington’s lack of income tax lasts past 2027 for households near $1,000,000 of AGI.
Frequently asked questions
Do I pay tax on an inherited 401(k) if I leave it alone?
No. Tax is owed only when money comes out. But as a non-spouse beneficiary you usually must empty the account by the end of the 10th year after the year of death, and you may owe annual minimums in the meantime if the owner had already started RMDs. Leaving it alone indefinitely is not an option for most adult children.
Is an inherited 401(k) subject to the 10% early withdrawal penalty?
No. Distributions made to a beneficiary because of the account owner’s death are exempt from the 10% additional tax at any age. Ordinary income tax still applies to traditional, pre-tax money. This is one reason an inherited 401(k) can fund a low-income gap year efficiently, even for a beneficiary in their thirties or forties.
Does California tax inherited 401(k) withdrawals?
Yes, if you are a California resident when you take them. California taxes them as ordinary income, up to 13.3% at the top (2025 rates). If you genuinely move out of California first, federal law prevents California from taxing retirement plan distributions you receive as a nonresident. Timing a move only for this reason rarely makes sense, but it matters if a move is already planned.
Your next step
Before taking any money out, get three things: the plan’s beneficiary distribution rules, the date of death and whether the owner had started RMDs, and your expected taxable income for the next few years. With those, the withdrawal schedule is usually a short decision. If you want it worked through alongside your RSUs and the rest of your tax plan, the Tax & Wealth Assessment from Age Five Family Office™ at Bright Advisers is built for that.
This article is general education, not individual tax, legal or investment advice. The right move depends on your family’s full picture.
Kevin has advised high-income W-2 tech and biotech families since 2015, and leads the education-first Age Five Family Office from Brea, California.
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