[zekester]

I am trying to clarify a situational concern I have. I have heard that if a person has a 401K with a former employer and they pass away, the spouse will have to pay taxes on the disbursement as if it were a normal income check. Is this correct, and if so, would this also apply if the person lost their job due to a plant closure?

[ebaines]

Depends on the specifics of your particular plan - you can check with the plan admin to see for sure. In some cases the beneficiary may be allowed to keep the 401(k) assets where they are, but this is not common. Most plans require the beneficiary to take the money out as a lump sum. If the beneficiary is a surviving spouse, he/she is allowed to roll the assets directly into an IRA without having to pay taxes (until such time as the money is withdrawn from the IRA). This option is only available to a surviving spouse - if someone else has been named the beneficiary of the 401(k) - such as a child - and the plan requires that the 401(k) assets be withdrawn, then they have to take the assets as a lump sum and will have to pay income taxes on it.

Here's a good site for more detail:
401khelpcenter.com - What You Need to Know When You Inherit a 401k

As for losing a job due to plant closure - you should be able to keep your 401(k) where it is, although if the amount is small (less than $5K) they may require that you take a disbursement. In this case you can roll the assets directly to a rollover IRA without paying any taxes or penalties.

[ScottGem]

ANY disbursement from a 401K is treated as regular taxable income. Doesn't matter what the reason for the disbursement or to whom. The purpose of a 401K it to invest PRE-tax earnings. The rationale is that, when one retires they will be in a lower tax bracket so the tax will be less.

If the recipient of the disbursement wishes they can roll the disbursement into an IRA to defer the tax liability until they actually want to use the money.

[AtlantaTaxExpert]

Ebaines covers it rather well. Some changes to the law has expanded the options of beneficiaries other than the surviving spouse for IRAs, but logically it should apply to 401Ks as well.