Pass the Baton, Not the Tax Bill

Many families are surprised to learn that inheriting an IRA can come with a significant tax bill. Recent changes to federal law have altered how inherited retirement accounts are distributed, making tax planning more important than ever.

Understanding the 10-Year Rule

Under the SECURE Act, most non-spouse beneficiaries who inherit a traditional IRA must withdraw all funds from the account within 10 years of the original owner’s death. Previously, beneficiaries could often “stretch” distributions over their lifetime, allowing the account to continue growing tax-deferred for decades.

Today, that option is generally limited to surviving spouses and certain eligible beneficiaries, such as disabled individuals or beneficiaries who are not more than 10 years younger than the original account owner.

For adult children and many other heirs, the accelerated withdrawal requirement can create a substantial tax burden.

Why Taxes Can Add Up Quickly

Unlike many other inherited assets, traditional IRAs do not receive a step-up in basis at death. As a result, distributions from inherited traditional IRAs are generally taxable as ordinary income.

If beneficiaries wait until the end of the 10-year period to withdraw the funds, they may face a large tax bill in a single year. Large withdrawals can push taxpayers into higher tax brackets and potentially affect other tax-related calculations.

Smart Distribution Planning for Beneficiaries

Rather than taking the entire balance at once, beneficiaries may benefit from spreading withdrawals throughout the 10-year period. This approach can help manage taxable income and potentially reduce overall taxes.

Because tax situations change from year to year, beneficiaries should review their withdrawal strategy annually. Factors such as employment income, retirement status, business income, and deductions can all influence the optimal distribution amount.

Planning Opportunities for IRA Owners

Individuals who are still accumulating retirement assets can take proactive steps to reduce future tax burdens for their heirs.

Consider a Roth Conversion

Converting a traditional IRA to a Roth IRA may create a current tax liability, but it can provide substantial long-term benefits. While most non-spouse beneficiaries must still empty an inherited Roth IRA within 10 years, qualified distributions are generally tax-free.

This allows inherited Roth assets to continue growing tax-free during the 10-year period and may significantly reduce taxes for future generations.

Evaluate Charitable Giving Strategies

For charitably inclined individuals, retirement accounts can be an effective asset to leave to charity. Because charitable organizations do not pay income tax on inherited IRA assets, this strategy may be more tax-efficient than leaving other assets to charity.

In some cases, more advanced planning tools, such as charitable remainder trusts, may help provide income to beneficiaries while ultimately supporting charitable causes.

Don’t Forget Beneficiary Designations

One of the most common estate planning oversights is failing to update beneficiary designations. Retirement accounts pass directly to the beneficiaries listed on the account paperwork, regardless of what a will may say.

Life events such as marriage, divorce, births, deaths, or changes in family relationships are good reminders to review beneficiary forms.

How DBMCPA Can Help

Inherited retirement accounts often present unique tax-planning opportunities. Whether you are a beneficiary receiving an inherited IRA or an account owner looking to protect future generations, proactive planning can help reduce taxes and preserve more wealth for your family.

If you would like to discuss your retirement account or estate planning strategy, contact a DBMCPA advisor to explore your options.