Inherited Retirement Accounts and the Ten Year Rule

When a retirement account is inherited, the most common instinct is also the most expensive one, which is to take the money out.

It feels like resolution. The account belonged to someone who is gone, and moving it into your own bank feels like completing something. But an inherited traditional retirement account is not a pile of money. It is a pile of money with unpaid income tax attached, and how you take it out determines how much of it you keep.

The rules changed significantly under legislation passed in recent years, and much of the advice still circulating predates that change. What follows is general, and the details depend on who died, when, how old they were, and what your relationship to them was. This is a conversation for a tax professional. But the shape of it is worth carrying into that conversation.

Start with the largest distinction, which is whether you are a spouse.

A surviving spouse has options nobody else has. She can generally treat the inherited account as her own, rolling it into her own IRA, at which point it behaves like any other retirement account she owns. She can also generally keep it as an inherited account, which has different consequences. Which choice is better depends heavily on her age and on whether she needs access before fifty nine and a half, because an inherited account can often be accessed without the early withdrawal penalty while an account treated as her own generally cannot. Women who roll immediately at fifty two, because rolling sounds like the responsible thing to do, sometimes lock away money they will need at fifty five.

For most non spouse beneficiaries, an adult child inheriting from a parent being the common case, the rule now is generally that the account must be fully emptied within ten years of the year of death.

That is the headline, and it replaced the older approach that allowed distributions to be stretched across a beneficiary's lifetime. The older approach let a fifty year old daughter spread an inherited account across three decades of small withdrawals. The ten year rule compresses the same money into a single decade.

There is an additional wrinkle that has caused enormous confusion, which is whether annual distributions are required during those ten years or whether the account can simply be emptied in year ten. The general answer depends on whether the person who died had already begun taking required minimum distributions. If they had, annual distributions during the ten year window are generally required in addition to emptying it by the end. If they had not, the annual requirement generally does not apply.

Certain beneficiaries are treated differently and can still use a longer approach. Broadly, this includes a surviving spouse, a minor child of the person who died, someone who is disabled or chronically ill, and someone not more than ten years younger than the decedent. Note that a minor child of the decedent qualifies while a grandchild generally does not, and that the treatment typically shifts once the child reaches majority.

Inherited Roth accounts follow the ten year emptying rule as well for most non spouse beneficiaries, but qualified distributions are generally not taxable, which makes the timing decision entirely different. With a Roth, there is often an argument for leaving it untouched until the final year and allowing it to grow tax free for the full decade.

Here is where the planning actually happens, and it is not complicated.

Ten years is not a deadline to be met in year ten. It is a ten year window in which you control the timing of taxable income. An adult daughter who inherits a substantial traditional IRA and takes it all in one year may push herself into the highest brackets she will ever occupy, and may also trigger effects she did not anticipate, including Medicare premium surcharges if she is sixty five or older, and reduced eligibility for income based benefits or aid.

Spread across ten years with attention to her own income pattern, the same account can be withdrawn at meaningfully lower total tax. The high income years can take less. The year she retires, or the year between jobs, or the year her own income drops for any reason, can take more.

That is the entire strategy, and it requires only that the account not be liquidated in a moment of grief.

A few practical points. Do not roll an inherited account into your own IRA unless you are a spouse, because for a non spouse that transaction is generally not permitted and can be treated as a full taxable distribution. Retitle the account properly as an inherited account with the decedent's name reflected. Confirm whether the person who died had already satisfied their required distribution for the year of death, because if not, someone has to take it. And check for a designated beneficiary on the inherited account itself, since your beneficiaries matter now too.

The money is not going anywhere. The account can sit, correctly titled, while you find someone to help you plan the withdrawals.

What cannot be undone is a single distribution taken in the first month because it felt like the responsible thing to do.