How to Navigate Required Distributions from an Inherited IRA
The so-called Great Wealth Transfer is no longer a distant concept. Rather, it’s actively unfolding with trillions of dollars moving from Baby Boomers to their heirs. And with much of that wealth sitting inside tax-deferred workplace retirement accounts for Millennials and Gen Z beneficiaries and traditional individual retirement accounts (IRAs), this inheritance often arrives with some unexpectedly complex tax rules.
When a person inherits an IRA from a loved one, they generally must transfer the assets into what’s known as an inherited IRA—a special type of account designed for a non-spouse beneficiary. Unlike a traditional or Roth IRA, which allows the original owner to keep funds growing tax-deferred or tax-free for decades, an inherited IRA comes with strict distribution rules.
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Under current law, most beneficiaries are required to withdraw all money from the account within 10 years, which can create tax complications and financial planning challenges. The IRS has recently issued guidance clarifying how and when these withdrawals must be made. But even with these clarifications, many inheritors remain unsure about their obligations.
For years, confusion has surrounded required minimum distributions (RMDs) from inherited IRAs, particularly after the 2019 SECURE Act eliminated the ability for most non-spouse beneficiaries to “stretch” withdrawals over their lifetimes. The IRS has since issued multiple rounds of guidance, most recently clarifying some of the lingering questions about how and when heirs must take distributions.
The SECURE Act replaced the lifetime stretch with a “10-year rule.” Today, non-spouse beneficiaries generally must empty the account within 10 years of the original IRA owner's death. But what if said owner is 73 or older and has already begun taking RMDs?
Initially, it was widely assumed the new rules meant that inheritors could wait until year 10 and withdraw the entire balance in a lump sum. However, the IRS later clarified that if the original owner had already started RMDs before their death, beneficiaries must continue taking annual distributions in years 1 through 9 before fully depleting the account by year 10.
These RMDs are calculated based on the heir’s life expectancy, using IRS tables. However, unlike the old stretch IRA rules, the balance must still be fully withdrawn by the end of the 10th year.
For instance, if a 50-year-old inherits a traditional IRA from a parent who had already begun RMDs, they must take yearly withdrawals based on their own life expectancy for 9 years before depleting the account entirely in year 10. On the other hand, if the original owner passed away before beginning RMDs, the beneficiary has more flexibility and can choose to withdraw funds at any time within the 10-year window, provided the account is empty by the end of the period.
Roth IRAs follow similar inheritance rules but with a key difference. Since Roth accounts don’t have RMDs during the original owner’s lifetime, their beneficiaries are not required to take annual distributions within the 10-year period. They still must empty the account by the end of the term, but they can allow tax-free growth to continue until then.
One of the biggest concerns for beneficiaries is the tax impact of withdrawing large sums in a relatively short period. Since withdrawals from a traditional IRA are taxed as ordinary income, spreading those distributions over multiple years can help manage the tax bite.
A person in their last few working years may, for example, choose to take smaller distributions initially and leave a larger balance for when they enter retirement and fall into a lower tax bracket. However, someone else might decide to coordinate distributions within a year where they have a large deductible expense, such as a charitable donation.
Ultimately, these decisions often have to be made by heirs in their peak earning years, which helps explain why the SECURE Act’s rules have made the Great Wealth Transfer even more complicated. What was meant to be a financial legacy passed down from a parent has, for many heirs, become a short-term tax burden they were never warned about.
While the IRS has clarified the rules surrounding inherited IRA distributions, there is still plenty of room for confusion, particularly for heirs who initially misunderstood their obligations under the 10-year rule. Understanding whether annual RMDs apply, the tax implications of different withdrawal strategies, and the best timing for distributions can help beneficiaries make the most of their inherited accounts while avoiding costly mistakes.
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Malcolm Ethridge is the Managing Partner at Capital Area Planning Group, based in Washington, D.C. His areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
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Disclosures:
The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your legal advisors before taking any action that could have tax and legal consequences.
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