Inherited IRA Rules: What Beneficiaries Need to Know

There is a box on a form that has quietly cost American families more money than almost any other box in finance.

It shows up when someone inherits a retirement account. The custodian sends paperwork asking how you would like to receive the funds, and one of the options amounts to: just send it to me.

It looks like the simple choice. It is presented like the simple choice.

Tick it on a $312,000 inherited IRA and you have added $312,000 to your income for that year. All of it, in twelve months, stacked on top of whatever you already earn, taxed at the top rates you have ever touched.

And there is no undo. A non-spouse beneficiary generally cannot put the money back.

The reason this happens so often is not carelessness. It is that the form offers a fast answer, nobody explains the alternative, and the person filling it in has a hundred other things to handle that month.

So before anything else, the one sentence that matters.

Do not accept a check. Ask for a trustee-to-trustee transfer into a properly titled inherited IRA.

Everything else in this article is refinement. That sentence is the money.

This is the concept everything else hangs on.

When you inherit, you do not take over the deceased person's account. You open a new, separate account in a specific registration format that identifies both of you.

Something like: "Jane Doe, deceased, IRA FBO John Doe, beneficiary."

That titling is not cosmetic. It is what keeps the account tax-deferred rather than triggering an immediate distribution.

And this account is legally a different animal from your own IRA.

You cannot contribute to it. You cannot merge it with your own IRA. You cannot roll it into your 401(k). Its required withdrawals cannot be satisfied from your own accounts, or theirs from it.

If you inherit from two people, you keep two inherited IRAs.

The one exception is a surviving spouse, and it is a large exception.

Almost every rule in this subject branches here.

Look at the second-to-last row, because it contains a genuine trap for young widows and widowers.

Inherited IRAs are exempt from the ten percent early distribution tax. Always, at any age.

So a 48-year-old surviving spouse who needs the money has a choice. Keep it as an inherited IRA and withdraw penalty-free. Or treat it as their own, which is better long term, but locks the money behind 59½.

Roll it over too early and you have handed yourself a penalty wall for more than a decade.

The usual sequence for a younger surviving spouse is to keep it inherited until 59½, then treat it as their own. You generally get to change your mind in that direction, not the other.

The IRS covers beneficiary distribution rules here, and Publication 590-B works through the categories in detail.

For most non-spouse beneficiaries, the account must be emptied by the end of the tenth year following the year of death.

Simple enough. Here is what people misunderstand.

Ten years is not ten equal payments.

Nothing requires you to take a tenth each year. The requirement is that the balance reaches zero by the deadline.

Which means the timing is yours to control, and controlling it well is worth a great deal.

But sometimes annual withdrawals are also required.

This is the wrinkle that confused even tax professionals for several years.

If the original owner had already begun their own required distributions before dying, most non-spouse beneficiaries must take annual amounts during the ten years and empty the account by year ten.

If the owner died before reaching their required beginning date, there are generally no annual requirements. Just the ten-year deadline.

So the first question a beneficiary should ask is not "how much do I take." It is: had the deceased started their required withdrawals?

That single fact changes your obligations for a decade.

Row three is worth flagging. An inherited Roth IRA generally carries no annual requirement, so the beneficiary can let it grow tax-free for nine years and take everything at the end.

That is the best version of this deal that exists.

Some beneficiaries get to stretch withdrawals over their own life expectancy instead. The law calls them eligible designated beneficiaries.

A surviving spouse. A minor child of the deceased, until they reach majority, after which the ten-year clock starts. Someone who is disabled or chronically ill. And anyone not more than ten years younger than the deceased.

That last category is the one people overlook. A sibling, a partner, or a close friend of similar age often qualifies, and the difference between life-expectancy withdrawals and a ten-year compression is enormous.

Note the minor child rule carefully. It is a minor child of the account owner. A grandchild does not qualify, which surprises families who assumed leaving an IRA to grandchildren would stretch it further.

It does the opposite.

Here is the tax problem nobody sees coming.

Most people inherit in their forties and fifties. Peak earning years.

So the deceased's deferred tax bill lands on top of the beneficiary's highest-earning decade, at their highest marginal rate.

Watch what naive timing does to a $300,000 inherited traditional IRA held by someone earning $130,000.

Row two catches the people who are trying to be clever. Letting a pre-tax account grow untouched for nine years means a larger balance forced out in a single year at the worst possible rate.

Deferral is only valuable when the eventual rate is lower. Here it is usually higher.

Row four is the real answer, and it requires thinking ahead. If you plan to retire in year seven of the ten, that is when the cheap withdrawals happen.

The reverse is true for an inherited Roth. There, letting it grow for nine years costs nothing, because the withdrawal is tax-free whenever it happens.

Traditional: spread it out, front-load into cheap years. Roth: let it ride.

If the account was left to more than one person, there is a split deadline, and missing it can penalise everybody.

When multiple beneficiaries are named, the account should generally be divided into separate inherited IRAs by the applicable deadline in the year after death.

Do that, and each beneficiary uses their own category and their own timeline.

Fail to split, and the group can be forced onto the least favourable schedule among them.

So one beneficiary who is a charity, or an estate, or simply a different category, can drag everyone else down to a shorter payout window.

This is genuinely the most time-sensitive item in the whole process, and it lands during the months when a family is least able to deal with it.

Which is why the instruction is short and blunt: split first, decide later.

Splitting costs nothing and preserves every option. Deciding what to do with your share can wait.

A small trap with a real penalty attached.

If the deceased was already subject to required distributions and had not taken that year's amount before dying, it still has to come out.

By the beneficiary. In that same calendar year.

Somebody who dies in November may well not have taken it. Their heirs have weeks, in a month already full of other obligations, to notice and act.

Missing a required amount carries an excise tax on the shortfall, though there is a reduced rate if corrected promptly and relief is available for reasonable cause.

The IRS required minimum distribution FAQs cover the mechanics, and the waiver is requested on Form 5329.

So the first question to a custodian is: has this year's required distribution been taken?

Marcus and Dana inherit a $400,000 traditional IRA from a parent, split evenly. Both are 51. Both earn around $140,000.

Same account. Same amount. Same rules.

Marcus wants it dealt with.

He signs the form, takes his $200,000, and moves it to a brokerage account.

That $200,000 lands on top of his salary. His income for the year is $340,000. A large slice of the inheritance is taxed in the highest brackets he has ever touched, and his state takes its share on top.

He keeps roughly $125,000 of it.

The rest of the decade is uneventful, because there is nothing left to manage.

Dana transfers hers into an inherited IRA.

Her father had already started his required distributions, so she takes annual amounts. She works out her own plan across ten years rather than a flat tenth.

Years one through five she takes modest amounts, roughly $12,000 a year, keeping her income where it already sits.

In year six she goes part time to care for her mother. Income drops sharply. She takes $45,000 that year at a much lower rate.

Year seven she retires at 58. No salary. She takes $60,000 against almost no other income.

Years eight through ten clear the remainder while she is still in the gap before Social Security, in the cheapest tax years of her adult life.

Meanwhile the balance kept growing tax-deferred the whole time.

She keeps roughly $209,000 of an account that was worth $200,000 when she inherited it, because growth outpaced the tax she paid at lower rates.

The gap between the two siblings is about $84,000.

Marcus did not make a reckless decision. He made a fast one, at a moment when a form offered him a simple option and nobody told him the simple option was the expensive one.

Everything above changes character when the account is a Roth, and almost entirely for the better.

Qualified withdrawals are generally tax-free to you. There is usually no annual requirement during the ten years. The only real obligation is emptying it by the deadline.

Which means the optimal strategy is close to the opposite of the traditional version. Do nothing for nine years. Let it compound, tax-free, in an account you do not owe anything on.

Then take it all in year ten.

Two details worth knowing.

The five-year clock is the original owner's, not yours. If the original owner opened their first Roth IRA in 2009, that seasoning passes to you, and the earnings are qualified regardless of how recently you opened your inherited account.

If the owner opened it very recently, the earnings may not be qualified until the period is satisfied. The contributions still come out clean.

And you still cannot merge it with your own Roth IRA, unless you are the surviving spouse. It stays a separate inherited account with its own deadline.

What a Roth means for the person leaving it behind, rather than receiving it, is covered in what happens to a Roth IRA when you retire.

You inherited a 401(k) rather than an IRA.

The plan's rules apply, and some plans force a much faster payout than the law requires. A lump sum within a year or two is not unusual.

A non-spouse beneficiary can generally move it to an inherited IRA through a direct trustee-to-trustee transfer, which usually restores the longer timeline. Do this before accepting anything.

You inherited from someone who also had an inherited IRA.

A successor beneficiary generally inherits the remainder of the existing schedule rather than starting fresh. If your parent was three years into a ten-year window, you get the remaining seven.

The account holds nondeductible basis.

Some of every withdrawal may come out untaxed. Look for old Form 8606 filings in the deceased's tax records. Families routinely overpay tax because nobody checked.

You are the beneficiary and also the executor.

Keep the roles separate. The IRA passes outside the estate, so it is not an estate asset to be administered. Treating it as one creates confusion and delay.

The estate was named instead of a person.

Then it is not a designated beneficiary, the payout window is shorter, and the money runs through probate. Little can be done afterwards. This is the strongest argument for checking your own forms, covered in what happens to your retirement accounts after you die.

A trust was named.

Whether the trust looks through to individuals, or is treated as a non-person, depends on its drafting. A trust written before the current rules may behave in ways its author never intended.

You do not want the money.

A qualified disclaimer can pass it to the contingent beneficiary, which is sometimes deliberate. The rules are strict, generally requiring action within nine months and before accepting any benefit.

You inherited a Roth IRA.

Generally tax-free, generally no annual requirement, still a ten-year deadline for most. The owner's five-year clock carries over, so an account they opened long ago passes that seasoning to you.

You need the money now and you are under 59½.

Inherited IRAs are exempt from the ten percent additional tax. You still owe ordinary income tax on traditional money, but there is no penalty layer.

A reference, because beneficiaries ask these in roughly this order and the answers are counterintuitive.

Row seven is the one almost every beneficiary forgets.

You can and should name a successor beneficiary on the inherited account. If you die in year four of a ten-year window, that account passes to whoever you named, and they finish the remaining years.

Leave it blank and it goes to your estate, with all the delay and compression that implies.

Row five matters practically. You are not stuck with your parent's brokerage. A trustee-to-trustee transfer to a custodian you prefer is allowed and does not disturb the tax treatment.

Just never take possession of the money yourself in between.

A sequence, in order, because order matters here.

Do not sign anything that says distribute, liquidate or pay out.

Order ten certified death certificates. Every institution wants one and most will not return it.

Ask the custodian whether the deceased had taken this year's required distribution.

Ask whether the deceased had reached their required beginning date. This determines your obligations for ten years.

If there are multiple beneficiaries, get the account split into separate inherited IRAs.

Open your inherited IRA with the correct titling and request a trustee-to-trustee transfer.

Look through the deceased's tax records for Form 8606 filings showing basis.

Then, and only then, work out a withdrawal schedule across the full window, thinking about which of the next ten years will be your cheapest.

One consequence that beneficiaries discover a year late.

Withdrawals from an inherited traditional IRA are ordinary income, which means they do more than generate their own tax bill. They move every threshold that runs off your income.

If you are on a marketplace health plan, a large withdrawal can cut your premium assistance or eliminate it. That is a cliff, not a slope.

If you are already past 63, the withdrawal helps set your Medicare premium two years later. Also a cliff, applied in tiers.

If you have long-term capital gains, extra ordinary income can push them from one rate to the next.

If you are collecting Social Security, it can drag more of your benefit into the taxable column.

And if you have children in college, it can affect financial aid calculations that use a prior tax year.

None of these appear on the custodian's distribution form. None of them are mentioned when you call to request a withdrawal.

Which is why the ten-year window should be planned against your own tax return rather than against the account balance. The right question is never "how much can I take." It is "what is the highest amount I can take this year without crossing something."

For someone with a large inherited balance and a decade to clear it, that question is worth asking once a year with an accountant. The difference between doing that and taking an even tenth is frequently five figures.

An inherited IRA is not a windfall to be collected. It is a ten-year tax planning problem that arrives with a form attached.

The worst outcome is a single box, ticked early, that turns a $300,000 account into one enormous taxable year with no way back.

The best outcome comes from three unglamorous moves. Transfer rather than distribute. Split the account if there are several of you. Then spread the withdrawals across the window, front-loading whichever years your own income happens to be low.

A surviving spouse has more options than anyone else and should be slow about using them, because treating the account as your own before 59½ closes a door.

And if the account is a Roth, most of this pressure disappears. Let it grow, empty it by the deadline, pay nothing.

Ten years sounds like plenty of time. It is, if you start thinking in year one rather than year nine.

See you next issue. 🪙

This is general education, not financial, tax or legal advice. Beneficiary categories, the ten year rule, annual withdrawal requirements, account splitting deadlines, successor beneficiary rules and plan specific payout terms are set by federal law and individual plan documents, and both change over time. Several of the steps described here cannot be undone. Speak to a tax professional before signing any distribution paperwork.

Sources: IRS guidance on required minimum distributions for IRA beneficiaries, retirement plan beneficiaries, required minimum distribution FAQs, Form 5329, Form 8606, and Publication 590-B on distributions from individual retirement arrangements.