Non-Spousal Inherited IRAs: Avoid Tax Deferrals that Increase Your Taxes
As a financial planning firm, we at Tableaux Wealth admittedly have a bias that much of life planning can benefit from financial planning. But thanks to a federal law change in 2020--with additional rules effective in 2025--we think that inheriting an IRA is a particularly good excuse to check in with your financial advisor.
The SECURE Act of 2019 significantly changed the rules governing the distribution of IRAs inherited by anyone other than a spouse (“non-spousal beneficiaries”). Until 2020, the beneficiary of an inherited IRA could “stretch” distribution of the IRA through required minimum distributions (RMDs) based on their own life expectancy (as determined by the IRS). This meant that beneficiaries of inherited IRAs—particularly those significantly younger than the original IRA owner—could defer a significant amount income taxes by spreading out the RMDs over many years, often decades.
The SECURE Act imposed a 10-year distribution rule on nearly all non-spousal beneficiaries[i]. (Note that spousal beneficiaries are exempt from this new rule and also continue to give these beneficiaries the option of rolling over inherited IRAs into their own IRA).
Essentially, the new rule mandated that inherited IRAs be fully distributed by the end of the 10th year starting the year after the IRA owner’s death. But the 2019 law did not specify how those funds needed to be withdrawn within that 10-year window—i.e. in equal installments, as a lump sum, or with RMDs for 9 years followed by the remainder in year 10. Non-spousal inherited IRA beneficiaries could choose among those options. And when faced with that choice, many beneficiaries were quick to assume that the general rule concerning tax-advantage retirement accounts applied: that it’s better to allow retirement assets to grow and defer payment of taxes as long as possible. However, that was and is not always a wise bet.
A couple of years after the 10-year rule went into effect, our colleague and director of financial planning Luke DeLorme examined whether that assumption about deferring distributions was true. He published his findings in the Journal of Financial Planning, in an article comparing the tax implications of two different withdrawal strategies: 1) delaying any distributions of an inherited IRA until the 10th year, and 2) spreading out distributions over the 10-year period.
Luke ran a number of hypothetical scenarios for a married beneficiary filing jointly, with annual incomes ranging from $50k to $500k and the inherited IRA’s value ranging from $25k to $1million. After crunching the numbers, he found that in the majority of cases it was not beneficial to defer distribution to the tenth year. In these cases, deferring triggered higher taxes (by way of higher marginal and effective tax rates) in the year of distribution. Instead, at least from a tax perspective, it was usually beneficial to spread the withdrawal over the 10-year period and reinvest the distributions.
In 2024, Vanguard conducted a similar, robust study into the relative benefits of different inherited IRA withdrawal strategies. That study examined over 1,500 scenarios, with varying rates of growth (3%, 5%, and 7%), starting balances of the inherited IRA ($100k, $315k, $700k, and $1M), inflation rates (0.5%, 2.35%, and 4.5%), levels of taxable income (seven, all $100k and above, representing tax brackets over 12%) and more variables.
For every combination, Vanguard compared the comprehensive tax impact of three distributions strategies: 1) a complete distribution in year 10; 2) RMDs taken in years 1-9, and the remaining balance in year 10; and 3) approximately equal annual distributions over the 10-year period. Out of the 1,500 plus studied combinations, strategy 3--equal annual distributions--was the most beneficial from a tax perspective in 1,488 scenarios! Strategy 2 resulted in the lowest taxes in the 12 remaining cases. It was very clear that if a beneficiary fell within the study’s assumed ranges, deferring distribution until year 10 probably did not make financial sense.
Changes in 2025
In 2025, the IRS implemented an additional rule governing withdrawal of non-spousal inherited IRAs. Although this rule doesn’t affect the analyses of Luke’s or Vanguard’s studies, it does limit a beneficiary’s withdrawal options in many cases. Effective this year, if an IRA owner dies after reaching the age 73, the current age at which RMDs must be taken,the non-spousal beneficiary must take, at least, annual RMDs (calculated based on the beneficiary’s life expectancy) over the 10-year period, and a distribution of the remaining balance by the end of the 10th year. If the IRA owner had not yet begun taking RMDs before passing, however, the beneficiary may wait until the 10th year to distribute the funds.
While both Luke’s and Vanguard’s studies provide ample evidence that a prudent default strategy should be to evenly spread out distributions over the 10-year period, it is equally true that in many situations it does not make sense to do so. For example, if the size of the inherited IRA is small and the annual income of the beneficiary is high, deferring to the 10th year may be beneficial. Similarly, if a lump sum distribution in the 10th year would not significantly raise the beneficiary’s tax bracket and effective tax rate, there is no need to spread out the distribution.
The real world contains many more variables than those accounted for in studies, and those variables can influence the decision on when and how to take distributions. An expected drop in future income, a job with varying income from year to year, unexpected impacts on Medicaid or Medicare premiums from RMD income, and changing state income tax levels for the beneficiary, for example, can all meaningfully change the analysis.
A financial planner who takes a comprehensive look at your current financial situation and any anticipated changes can help you decide how to best distribute funds from your inherited IRA.
[i] Exceptions to the 10-year rule apply in certain cases, including certain eligible minor children and disabled or chronically ill beneficiaries.