The Little-Known 401(k) Rule That Could Cost You $12,500 the Year You Inherit

A reader on a popular retirement forum recently described a situation that catches thousands of heirs off guard each year. Her mother died in March at age 80 with roughly $1 million in a 401(k). The daughter, 62 and still working, assumed she had a full decade to drain the account under the well-publicized 10-year rule. She did not realize the clock started ticking the day her mother died, and that a small, separate rule was about to cost her $12,500.

The Year-of-Death RMD Trap

The 10-year rule for non-spouse heirs of a 401(k) is widely understood. The exception buried underneath it catches heirs off guard. If the original account owner was already required to take annual distributions and died before completing that year’s withdrawal, the beneficiary inherits the obligation. The IRS expects the deceased’s unfinished required minimum distribution to leave the account by December 31 of the year of death, calculated against the owner’s life expectancy, not the heir’s.

Suze Orman put it bluntly on her podcast: for accounts where the owner had already started withdrawing, “you cannot wait till the 10th year for you to withdraw all of that money… You had to start the year after the owner died to continue to take required minimum distributions based on your life expectancy.” The year-of-death distribution comes even before that schedule begins.

The penalty for missing it is steep. A $1 million balance at age 80 generates an RMD of roughly $50,000 under the IRS Uniform Lifetime Table. Skip it and the excise tax is 25% of the shortfall, which works out to $12,500. That is a check written to the Treasury for doing nothing wrong other than not knowing the rule existed.

How to Unwind the Penalty

The fix is straightforward if caught quickly. File Form 5329 with the IRS, take the missed distribution, and the excise tax drops to 10% when corrected within two years. Attach a reasonable-cause statement explaining the oversight and request a full waiver. The IRS routinely grants these waivers when the heir corrects the error in good faith. A $12,500 problem becomes a $5,000 problem, and frequently a zero-dollar problem, with one form and a short letter.

The catch is that the correction has to be intentional. The penalty accrues silently, and most custodians will not flag it for you. A 401(k) plan administrator processes the death notification, opens an inherited account in the beneficiary’s name, and moves on. Nothing in that workflow checks whether the deceased had satisfied the current year’s RMD.

The Tax Cascade Most Heirs Miss

The other half of this problem is what the inherited distribution does to the heir’s own tax picture. A 62-year-old still earning a salary who takes a $50,000 year-of-death RMD on top of regular wages may jump into the 24% federal bracket. If that pushes modified adjusted gross income above roughly $106,000 single or $212,000 joint (the first IRMAA tier), Medicare Part B and Part D premium surcharges arrive two years later, even if the heir is not yet enrolled in Medicare today. Once enrolled, that one-time inheritance event triggers monthly surcharges of $70 to $400 per person for a full year.

Stack the inherited RMD against the heir’s own 401(k) contributions, Social Security planning, and the 10-year drawdown that begins the following year, and a single missed deadline cascades into several years of higher taxes and Medicare premiums.

Three Steps Worth Taking Now

1. Pull the deceased’s prior tax records within 30 days. Look at the most recent 1099-R from the 401(k) custodian and confirm whether the full year’s RMD was distributed before the date of death. If the answer is no, calculate the remaining amount using the IRS Uniform Lifetime Table and request the distribution before December 31.
2. If the deadline already passed, file Form 5329 immediately. Take the missed distribution, attach a reasonable-cause explanation, and request a waiver of the excise tax. The IRS grants these routinely for first-time errors discovered within two years.
3. Model the inherited distribution against your own income before December. If the combined number crosses the first IRMAA threshold or pushes you into a higher bracket, consider accelerating deductible contributions to your own 401(k) or HSA in the same calendar year to blunt the impact. The math on a fee-only advisor pays for itself at this threshold.