Distribution

• Your employer is allowed to set up its own rules for a 401(k) as long as the rules don't violate IRS requirements. If you're named as the account's beneficiary, the plan rules determine whether you can make withdrawals gradually or if you must take the contents out in a lump sum. Most plans require the lump sum approach so that the plan administrator can close the book on the account.
  
  

Taxes

• As an account beneficiary, you can access the money in the 401(k) without going through probate, but the account is still part of the deceased's estate. If the estate is big enough to pay federal estate taxes, the 401(k) will share the burden. In addition, you'll have to pay income tax when you withdraw money from the account, and depending on the law in your state, you may owe state inheritance and income taxes as well.
  
  

Rollover

• One way to minimize the tax bite is to set up an Individual Retirement Account and have the 401(k) administrator roll over your inheritance into the IRA. This option used to be reserved for the spouse of the account owner, but the government loosened the rules in 2006. Rolling over the money won't protect it from the estate tax, but you won't have to pay income tax until you withdraw it from the IRA. You must have the administrator roll over the money directly without handling it yourself if you want to avoid paying income tax.
  
  

Withdrawals

• Once you roll over the money to the IRA, you'll have to start withdrawing money just as you would if you'd inherited the IRA. That means you take a minimum withdrawal from the account each year, based on IRS life-expectancy tables: If the tables show you have 40 years to live and the account has $120,000, for instance, you'd have to withdraw at least $3,000, though you can always take more. If you only withdrew $500, the IRS will tax the remaining $2,500 for the year at a 50 percent penalty rate.