Taxation of Death Benefits in 401k plans

[Guest DDDAY]

When the spouse of deceased 401k participant receives a lump sum distribution, how is that taxed? Does the date of death have any relevance or is it 20% of market value on valuation date?

[Mary Kay Foss]

Apparently you are only thinking about income tax in your question. The date of death value is relevent if you're filing an estate tax return.

For income tax purposes there are choices. A spouse can rollover a lump sum to an IRA and not pay tax until its withdrawn from the IRA.

Depending upon the age of the plan participant, 10 year averaging may still be available. But fewer and fewer people qualify.

If there is appreciated employer stock in the lump sum, there is special income tax treatment for the unrealized appreciation.

There is no 10% penalty for an inherited benefit, so you don't have to worry about that aspect.

A 20% tax is unlikely to happen. The lump sum in not treated as a long term capital gain in total.