CONTRIBUTED CONTENT: Inheriting an IRA? The 10-year rule your kids need to know about
Robert J. Green, Esq.
For many Idaho families, a retirement account is one of the largest assets they'll pass on, sometimes larger than the house. But the rules for inherited IRAs and 401(k)s changed significantly in recent years, and many parents (and their children) still assume the old rules apply. That assumption can lead to a surprisingly large tax bill.
What Changed: The End of the "Stretch" IRA
Before 2020, a child who inherited an IRA could generally "stretch" withdrawals over their own life expectancy. A 40-year-old heir might take small distributions over 40+ years, letting the account keep growing tax-deferred for decades.
The federal SECURE Act ended that for most beneficiaries. For account owners who died after 2019, most non-spouse beneficiaries must now empty the inherited account by the end of the tenth year after the owner's death. This is known as the 10-year rule.
Who Is Affected
The 10-year rule applies to most adult children, grandchildren, siblings more than 10 years younger than the account owner, and other non-spouse beneficiaries.
Certain "eligible designated beneficiaries" are exempt and can still use life-expectancy payouts, including:
• A surviving spouse
• A minor child of the account owner (until age 21, after which the 10-year clock starts)
• A beneficiary who is disabled or chronically ill
• A beneficiary not more than 10 years younger than the account owner
The Detail Many Heirs Miss
It's not always as simple as "withdraw everything sometime within 10 years." Under IRS regulations, if the original owner had already begun taking required minimum distributions (RMDs) before death, the beneficiary must generally take annual distributions in years one through nine and then empty the account by year ten.
Missing a required distribution can trigger an IRS penalty of up to 25% of the amount that should have been withdrawn (reduced in some cases if corrected promptly). The IRS waived these penalties for several years while the rules were being finalized, but that grace period has ended.
Why This Matters: Taxes
Withdrawals from a traditional inherited IRA are taxed as ordinary income, both federally and by Idaho. Compressing a large account into 10 years can push heirs into higher tax brackets, especially if they're in their peak earning years.
Consider a $600,000 IRA left to a daughter who is 50 and earning a good salary. If she waits and takes the entire balance in year ten, much of it could be taxed at her highest marginal rate. Spreading withdrawals across the full window often produces a much better result.
Planning Strategies to Consider
The good news is that thoughtful planning, by you now and by your heirs later, can soften the impact. Here are some strategies to consider in consult with your tax and legal advisors:
Review your beneficiary designations. Retirement accounts pass by beneficiary form, not by your will. Make sure your designations are current and coordinated with the rest of your plan.
Consider Roth conversions. Converting some traditional IRA funds to a Roth during your lifetime means paying tax now, possibly at a lower rate than your heirs would pay. Inherited Roth IRAs are still subject to the 10-year rule, but qualified withdrawals are generally tax-free.
Leave traditional IRA funds to charity. If you plan to give to charity at death, naming a charity as beneficiary of a traditional IRA can be highly efficient. The charity pays no income tax, and your heirs can receive other assets that don't carry an income tax burden.
Use a trust carefully. Naming a trust as beneficiary can protect a young, spendthrift, or vulnerable heir – so it is the right move in some cases. But trusts holding retirement accounts can run into issues where taxes are accelerated rather than controlled, so weighing pros and cons becomes important.
Talk to your heirs. A simple conversation about how the 10-year rule works can help your children plan withdrawals wisely instead of discovering the problem in year ten.
Get Your Plan in Line with the New Rules
If your estate plan or beneficiary designations were set up before 2020, they may have been built around rules that no longer exist. A review with an estate planning attorney, your CPA or financial advisor, can help make sure more of your retirement savings goes to your family rather than to taxes.
My law firm is currently offering free telephonic, electronic, or in-person consultations concerning probating estates or creating estate planning documents.
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Robert J. Green is an Elder Law, Trust, and Estate Planning Attorney and the owner of Kootenai Law Group, PLLC in Coeur d’Alene. If you have questions about estate planning, probates, wills, trusts, or powers of attorney, contact Kootenai Law at 208-765-6555, [email protected], or visit www.KootenaiLaw.com.
This has been presented as general information and not as legal advice. Do not engage in legal decision-making without the advice of a competent attorney after discussion of your specific circumstances.