"Should I have to pay tax"? Generally yes. Because the original owner never paid tax on the contributions or earnings, they are taxable to whomever withdraws them, even a beneficiary after the owner's death.
However, the beneficiary does not have to pay the additional 10% penalty for early withdrawal even if they are under age 59-1/2.
"...when I make a withdrawal..." When you make the withdrawal, you have the option of having some taxes withheld. It is a good idea to have tax withheld so you don't owe too much when you file your return. However, whatever you have withheld is not the actual tax you owe, it is an estimate. The actual tax you owe is calculated on your tax return when the income is combined with all your other income, dependents, deductions and credits. If you had too much withheld, you get the extra back as a refund, and if you have too little withheld, you will owe an additional payment.
As you are the spouse-beneficiary, you have several options for how to handle the 401k. You should review these soon after the account holder's death since some of your decisions have a time limit. In general, you can:
- rollover the funds into your own IRA or 401k and treat the money as part of your retirement funds. You then withdraw the money when you retire, and it is subject to the same rules as your other retirement funds, including the 10% penalty for early withdrawal.
- leave the inherited 401k where it is. You will be required to take RMDs (required minimum distributions) based on your life expectancy. (You can withdraw more each year if you want, but you must withdraw at least the minimum calculated for you.)
- Rollover the funds to an inherited IRA. Inherited IRAs have different rules than if you rollover the money to your own IRA, and it may be easier to access the money from an inherited IRA if you are under age 59-1/2. Rolling over the funds to an inherited IRA will also give you more investment options than leaving it in an inherited 401k, because investments in 401ks are sometimes limited by the employer.
