Understanding Changing Rules for Inherited IRAs

The regulatory and tax landscape around inherited retirement accounts has changed significantly in just a few years. The new rules are far less attractive for beneficiaries and may have serious ramifications for estate plans.

IRAs are the primary retirement savings vehicle and investment account for millions of Americans. This means that IRAs are also one of the most common assets people inherit from parents and other loved ones. The financial and emotional impact of inheriting an IRA can be difficult to manage, and new rules and vague guidance from the IRS in recent years has only added to the complexity.

Let’s look at what has changed, and the options beneficiaries have today.

SECURE Act Changes

The SECURE Act, passed in 2019, changed the rules for beneficiaries of retirement accounts in important ways.

Previously, those who inherited an IRA could employ a strategy known as the “stretch IRA,” which allowed beneficiaries to “stretch” withdrawals over their entire lifetimes. This meant minimal annual required minimum distributions (RMDs) and the ability to continuing growing assets on a tax-deferred basis for years, sometimes decades. While great for beneficiaries, this also had the effect of depriving the government of sorely needed tax revenue.

The SECURE Act restricted use of the stretch IRA, introduced the 10-year rule for certain beneficiaries, and created two primary “classes” of beneficiaries: eligible designated beneficiaries, and non-eligible designated beneficiaries.

Eligible designated beneficiaries include surviving spouses, people with disabilities, minor children, people with chronic illnesses, and individuals not more than 10 years younger than the decedent. This class of beneficiaries can still use the “stretch IRA,” taking distributions over their lifetimes. Minor children revert to the “10-year rule” when they turn 21.

Non-eligible designated beneficiaries are those who do not fit into the “eligible” category. The SECURE act eliminated the stretch IRA for these beneficiaries, instead requiring them to withdraw (and pay income tax on) the entire balance of an inherited IRA within 10 years.

To complicate things further, the IRS did not issue final rules on whether non-eligible designated beneficiaries would be required to take annual required minimum distributions (RMDs) until last year. Now the rules are clear: non-eligible designated beneficiaries who inherit from someone who had already begun taking RMDs are required to take minimum distributions every year. RMDs must begin in the calendar year following the original IRA holder’s death and then continue annually until the account is fully emptied by the end of year 10. 2025 is the first year that RMDs are required, and the rules only apply to IRAs inherited after 2019.

The Importance of Managing Taxes

The stretch IRA was once a valuable estate planning tool but required minimum distributions and the 10-year rule have made IRAs far less appealing from a tax-planning perspective. Distributions from IRAs are taxed as ordinary income, and large distributions could push some beneficiaries into higher tax brackets. Managing distributions over multiple years (rather than withdrawing only the required minimum distribution and waiting until year 10 to withdraw the balance) may make sense for some beneficiaries but not others. If a beneficiary’s income is variable, it may also make sense to withdraw more in low-income years and less in high-income years.

In cases where multiple beneficiaries exist, such as the adult children of an IRA owner, this can also create an unequal inheritance for beneficiaries who may be in in different tax brackets. Roth IRAs may be increasingly attractive in such situations. Beneficiaries of Roth IRAs must still withdraw the assets within 10 years, but withdrawals are tax-free. Once a traditional IRA had been inherited, it can no longer be converted to a Roth IRA.

Talk to Your Advisor

We encourage clients who have inherited retirement accounts or who plan to leave large retirement accounts to heirs to discuss planning strategies with their advisor sooner rather than later. Smart planning can reap huge rewards, while a lack of planning can be costly for you and your loved ones. As Tax Day approaches, now is a good time to cross this off your 2025 to-do list.