Yes, taxes will be owed, but the rules for inherited IRAs are easier than they used to be. Starting in 2007, children, unmarried partners, and other non-spouse beneficiaries are allowed to transfer an inherited 401(k) to an individual retirement account (IRA). They are then required to take annual withdrawals, but the amount is based on their own life expectancy. For example, a 30-year-old woman who inherits a 401(k) will have more than 50 years to withdraw all the money. During that period, the investment will continue to compound and grow.

Non-spouses need to handle an inherited 401(k) with care, however. Make one mistake, and you could find yourself stuck with a large tax bill. If you are unsure about how to proceed, consider hiring a certified public accountant or certified financial planner to advise you.

To stretch out withdrawals over your lifetime, you must set up an inherited IRA account. Unlike spouses, who can roll over an inherited 401(k) into their existing IRAs, non-spouses must set up a separate account known as an inherited IRA. Make sure the financial institution that handles the transaction understands how to properly title an inherited IRA. If you transfer the money to an existing IRA, you'll have to pay taxes on the entire 401(k) transfer. Also be sure to arrange for a direct transfer of the money. Ask the 401(k) plan administrator to send the money directly to the inherited IRA account.

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