02 Mar Is an inheritance tax due when a 401(k) is inherited?

Q. Is there an inheritance tax that must be paid if a non-minor is the beneficiary on a 401(k) account? If so, what is the percentage to be paid and when does the tax have to be paid?
— Beneficiary

A. There are several components to how the inheritance tax works.

Its assessment is based on several factors.

It is imposed where the assets being transferred to the beneficiary are from a decedent who was a resident of New Jersey at the time of death and where the beneficiary and/or the assets are not exempt, said Catherine Romania, an estate planning attorney with Witman Stadtmauer in Florham Park.

A New Jersey inheritance tax is also imposed where the decedent was a non-resident but owned real property in New Jersey no matter where the beneficiary lives or their age, she said.

If the beneficiary is a Class A beneficiary — namely a spouse, domestic or civil partner, a grandparent, parent, child, grandchild, or stepchild — then the beneficiary is exempt from the inheritance tax regardless of the type of asset being transferred, Romania said.

Similarly, charities are exempt, she said.

In all other cases, in order for an exemption to apply, the property must be specifically listed in the statute as being exempt, such as life insurance paid directly to a named beneficiary, she said.

A 401(k) account is not an exempt asset, therefore, a 401(k) will be subject to inheritance tax unless paid to a Class A beneficiary or a charity,, she said.

The percentage of tax to be paid will depend on whether the beneficiary is Class C or Class D, Romania said.

“A Class C beneficiary includes a decedent’s sibling or the spouse of decedent’s child, whether such child is alive or predeceased,” she said. “A Class C beneficiary is taxed at the rate of 11% up to the first $1.1 million, 13% on the next $300,000, 14% on the next $300,000, and 16% on amounts in excess of $1.7 million.”

Class D beneficiaries include anyone else, she said. If the Class D beneficiary receives a bequest of $500 or more, the tax is 15% of the first $700,000 and 16% of any amounts in excess.

“Unfortunately, in addition to the inheritance tax, distributions from the 401(k) may also be subject to income taxation as such distributions are made to the beneficiary, unless it is a Roth 401(k) account,” she said.

Consider working with an estate planning attorney or tax advisor who can look at the specifics of the estate and your particular situation.

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This story was originally published on March 2, 2023.

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