Inheriting a retirement account can provide a significant financial cushion, but the wrong withdrawal strategy could cost beneficiaries thousands in taxes.
Most non-spouse beneficiaries must empty an inherited Individual Retirement Account (IRA) within 10 years of the original owner’s death.
The IRS also resumed enforcing penalties in 2025 for missed required annual withdrawals in applicable cases, adding another potential cost to an already complicated process.
However, some of the biggest financial losses may come from how beneficiaries manage the 10-year withdrawal window. Three strategies could help them preserve more of their inheritance, and the first decision may have a greater impact than they realize.
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The 10-year rule creates a six-figure tax trap
The 2019 SECURE Act eliminated the old IRA rules allowing non-spouse beneficiaries to stretch RMDs over their own individual life expectancy, replacing those rules with a much shorter 10-year period for distributing inherited retirement account funds.
Under the rules outlined in IRS Publication 590-B, most non-spouse beneficiaries must withdraw the entire inherited IRA balance by December 31 of the 10th year following the account owner’s death.
The shortened withdrawal period can create a tax-bracket trap. A person who inherits a traditional IRA in middle age, keeps earning a steady salary, and takes only the required minimum distributions (RMDs) can be left with a six-figure balance in the final year, according to Kiplinger’s analysis.
Even spreading a $500,000 inherited IRA across 10 years of withdrawals could generate more than $120,000 in federal income taxes. In high-tax states, the combined tax bill could exceed $125,000, 24/7 Wall St. reported.
Justyn Volesko, Partner and Co-Head of Family Office at Cerity Partners, noted that the penalty for missed distributions catches many families off guard.
<strong>Missing an RMD on an inherited IRA is sometimes the biggest surprise, particularly because of the associated penalty,</strong>
Large inherited IRA withdrawals can also increase a beneficiary’s modified adjusted gross income (MAGI), potentially triggering the 3.8% net investment income tax.
This applies to taxpayers whose MAGI exceeds $200,000 for single filers or $250,000 for married couples filing jointly, according to IRS Topic 559. That levy stacks on top of ordinary income tax.
How the IRS tightened inherited IRA enforcement
Whether beneficiaries must make annual withdrawals during the 10-year window depends largely on when the original account owner died in relation to their required beginning date (RBD) for RMDs.
If the owner died on or after their RBD, the beneficiary generally must take annual RMDs in years one through nine and withdraw the remaining balance by the end of year 10, according to IRS guidance.
If the owner died before the RBD, no annual distributions are required, but the full balance must still be withdrawn by year 10.
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The IRS confirmed these annual RMD requirements in final rules issued in July 2024 after waiving penalties from 2021 through 2024, according to the Treasury Department. Enforcement is now fully active for 2025 and 2026.
A missed distribution triggers a 25% excise tax on the shortfall, which is reduced to 10% if the beneficiary corrects it promptly and files IRS Form 5329. Before the SECURE 2.0 Act of 2022, the penalty stood at 50%.
Not everyone is subject to the standard 10-year rule. Surviving spouses, minor children of the original account owner, disabled or chronically ill beneficiaries, and individuals no more than 10 years younger than the deceased may qualify as eligible designated beneficiaries.
These individuals can generally use alternative distribution rules that allow them to stretch withdrawals over a longer period.
The IRS now enforces inherited IRA withdrawal rules, requiring beneficiaries to meet annual RMDs or face penalties and strict 10-year deadlines.
Three strategies that shrink the inherited IRA tax hit
The first strategy is to spread withdrawals across the 10-year period rather than postponing most distributions until the final years. Pulling roughly equal amounts annually keeps taxable income lower and avoids higher brackets, Vanguard noted.
The second strategy is timing larger withdrawals around lower-income years, such as a gap between jobs or early years of retirement, 24/7 Wall St. stated.
Under 2026 federal tax brackets, a single filer stays at 24% up to $201,775 before crossing into 32%, according to IRS Revenue Procedure 2025-32.
Taking larger distributions during lower-income years could therefore reduce the overall tax burden, particularly when beneficiaries can avoid crossing into a higher marginal tax bracket.
The third strategy involves the original IRA owner rather than the beneficiary. Converting a traditional IRA into a Roth IRA during the owner’s lifetime can shift the tax liability to a generation that may be in a lower tax bracket. It also allows beneficiaries to inherit an account with tax-free qualified withdrawals, Fidelity explained.
Inherited Roth IRAs are still subject to the 10-year rule, but qualified withdrawals are tax-free, and there is no annual RMD requirement, IRS confirmed.
The potential savings are greatest when the original account owner pays a lower tax rate on the conversion than the beneficiary would face when withdrawing the inherited traditional IRA, Fidelity added.
What inherited IRA beneficiaries should do before year-end
Beneficiaries who already hold an inherited IRA should model a distribution schedule that minimizes income tax exposure across the full 10-year window rather than defaulting to annual minimums, Mercer Advisors recommended.
The firm also suggested working with both a financial adviser and a certified public accountant to develop a distribution strategy that accounts for income, tax brackets, and other financial obligations.
IRA owners considering Roth conversions should evaluate partial conversions across several tax years because filling the current bracket each year avoids a rate spike while reducing the taxable balance heirs must withdraw, Q3 Advisors noted.
Coordinating conversions with the owner’s retirement date or a lower-income year widens the window before the account reaches the next generation.
For beneficiaries approaching a December 31 withdrawal deadline, the first step should be confirming whether the original account owner had reached their required beginning date for RMDs. That detail determines whether annual withdrawals are required during the 10-year period, 24/7 Wall St. explained.
From there, mapping out projected income and tax brackets for each year can help beneficiaries identify the most tax-efficient withdrawal schedule and avoid leaving a potentially costly balance until the final year.
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