From Yahoo Finance · · 2m
The inherited 401(k) loophole most heirs never hear about
A non-spouse heir can roll a workplace 401(k) straight into an inherited Roth, but only while the money is still at the employer.
In brief
A non-spouse heir can roll a workplace 401(k) straight into an inherited Roth, but only while the money is still at the employer. If a parent's retirement money is in a 401(k), a non-spouse beneficiary can convert it to an inherited Roth. Move it to an IRA first and that right disappears forever. Originally reported…
A one-time escape hatch
Name a non-spouse on a workplace 401(k) and they can roll it straight into an inherited Roth IRA. Pay income tax once, then never again on that account.
The $400,000 example
A daughter inherits her father's $400,000 401(k). Instead of the default traditional inherited IRA, she has the plan wire it directly into an inherited Roth titled in her name.
One week could erase it
Had her father moved that same money into a traditional IRA before he died, the option would be gone. Non-spouse heirs cannot convert an inherited traditional IRA. Only a surviving spouse can.
Where the right comes from
Internal Revenue Code §402(c)(11), added by the Pension Protection Act of 2006, plus IRS Notice 2008-30. A 2008 law made the direct rollover mandatory, so the plan administrator cannot say no.
“the tax code hates them or hates the people who inherit the money and takes a lot of it in tax”
Who qualifies
Any non-spouse named directly on the beneficiary form: child, grandchild, sibling, partner, friend. Trusts count only if they meet the see-through rules.
Who gets shut out
You lose it if the money already sits in an IRA at death, if you inherit through the estate instead of as a named beneficiary, or if you accept a check before requesting the transfer.
Move it trustee to trustee
Confirm you are on the beneficiary form, open an inherited Roth titled "[Father's Name], deceased, IRA F/B/O [Your Name], beneficiary," and have the plan send it direct. Never touch the funds.
Pay the tax from outside
Estimate federal and state tax on the full pretax balance and cover it with cash from elsewhere. Plan withholding counts as a taxable distribution to you.
One year, one big bracket
The whole balance lands as ordinary income in a single year. That can push you to the top bracket and cost you ACA subsidies and cheaper Medicare premiums via IRMAA.
No takebacks, and a clock
The Tax Cuts and Jobs Act killed recharacterization, so a 30% market drop after converting $400,000 still leaves you taxed on the old balance. The SECURE Act also empties the account in 10 years.
The bottom line
If a parent's retirement money is in a 401(k), a non-spouse beneficiary can convert it to an inherited Roth. Move it to an IRA first and that right disappears forever.
