When a loved one passes away and leaves behind a traditional retirement account such as a 401(k), 403(b), 457(b), or IRA, the process of inheriting it can quickly become complicated. The tax rules governing these accounts have evolved over time, and the latest changes—finalized in 2024 and taking effect in 2025—introduce specific requirements depending on who the beneficiary is and when the original account holder passed away.
Mismanaging these inherited accounts can result in severe tax penalties and a significant loss of value. This article breaks down the latest IRS rules and provides a clear, step-by-step guide to help non-spouse beneficiaries navigate the process confidently.
Why Inherited Retirement Accounts Can Be a Financial Minefield
Inherited retirement accounts may seem straightforward, but misunderstanding Required Minimum Distributions (RMDs) can lead to costly mistakes. The IRS imposes steep penalties—up to 25% of the amount you should have withdrawn—if RMDs are missed or miscalculated.
The complexity arises because not all beneficiaries are treated equally. The IRS recognizes three main types:
- Designated beneficiaries – Living individuals who inherit an account.
- Eligible designated beneficiaries (EDBs) – Individuals who meet specific criteria, such as being disabled, chronically ill, a minor child of the deceased (until age 21), or not more than 10 years younger than the account owner.
- Non-designated beneficiaries – Entities like estates, charities, or certain trusts that do not qualify as “see-through” trusts.
Each group follows its own distribution rules. Misclassifying your status can trigger unexpected taxes and penalties.
Step 1: Determine Which Rules Apply to You
Your first step is identifying which category you fall into and whether the original account holder had reached their Required Beginning Date (RBD)—the point at which they were required to start taking RMDs.
- For IRAs, this is April 1 of the year after the owner turns 73.
- For workplace plans like 401(k)s or 403(b)s, there’s a “still working” exception. If the employee was still working and didn’t own more than 5% of the company, they may not have reached their RBD yet.
Once you know whether the account holder died before or after their RBD, you can follow the appropriate rule set.
Case A: The Account Owner Died Before Their Required Beginning Date
If the original account holder had not yet begun taking RMDs, non-spouse non-eligible designated beneficiaries fall under the 10-year rule.
Under this rule:
- There are no annual RMDs in years 1 through 9.
- The account must be fully distributed by December 31 of the 10th year after the year of death.
For example, if a parent dies in 2025, the inherited account must be emptied by December 31, 2035. Beneficiaries can choose to take withdrawals at any time within that window.
However, deferring withdrawals until the end can create a tax problem. Suppose you inherit $300,000 and leave it untouched for nine years, and it grows 8% annually. By year ten, it could exceed $700,000—and withdrawing that all at once would add a massive taxable income to that year. Spreading withdrawals evenly across the decade can help manage tax brackets more effectively.
Eligible designated beneficiaries, on the other hand, are not bound by the 10-year rule. They may take annual RMDs based on their own life expectancy, allowing for smaller withdrawals and continued tax-deferred growth. This arrangement, known as a stretch IRA, was once available to most beneficiaries before the SECURE Act of 2019. Now, it applies only to specific EDB categories.
There’s a special rule for minor children of the account owner: they may use life expectancy-based payouts until turning 21, after which the 10-year rule kicks in.
Case B: The Account Owner Died After Their Required Beginning Date
If the account owner had already begun taking RMDs, the beneficiary faces two simultaneous requirements:
- Continue annual RMDs in years 1–9 (the “at least as rapidly” rule).
- Empty the account by the end of year 10 following the year of death.
To calculate these annual RMDs, you must determine who has the longer life expectancy—you or the deceased—and use that as your divisor based on IRS life expectancy tables. This ensures the account is depleted “at least as rapidly” as the IRS requires.
For example, if an 80-year-old account holder with a 10-year life expectancy passes away and the beneficiary is 50 with a 34-year expectancy, the 34-year figure is used. This allows smaller withdrawals while still satisfying the IRS.
If the deceased hadn’t taken their RMD for the year before passing, the beneficiary must take it to avoid penalties. This one-time year-of-death RMD is separate from the beneficiary’s own RMDs, which begin the following year.
Eligible designated beneficiaries again have more flexibility—they can base distributions solely on their life expectancy without being required to empty the account within 10 years. However, when they pass away, their heirs lose that privilege and must follow the standard 10-year rule.
Non-Designated Beneficiaries: Estates, Charities, and Non-See-Through Trusts
If a non-person entity inherits the account, the rules become far less favorable.
- If the account owner died before their RBD: the account must be emptied within 5 years (the “five-year rule”).
- If the account owner died after their RBD: withdrawals continue based on the deceased’s remaining life expectancy (the “ghost life rule”).
These accelerated payout schedules can lead to higher taxable income sooner. Moreover, if no beneficiary was named at all, the account defaults to the estate, which must follow these same restrictive rules—often requiring probate and additional legal costs.
To avoid this, it’s critical to name qualified see-through trusts when estate planning. Properly drafted conduit or accumulation trusts can allow the IRS to “see through” to individual beneficiaries, enabling them to use more favorable 10-year or life-expectancy rules.
Key Deadlines and Mechanics to Remember
1. The 10-Year Rule:Most non-eligible beneficiaries must fully empty the account by December 31 of the 10th year after death.
2. Annual RMD Divisor:
Use the IRS Single Life Table from Publication 590-B. Each year, subtract one from your previous divisor—don’t recheck the table.
3. Beneficiary Determination Date:
September 30 of the year after death is the official cutoff for identifying who qualifies as a designated beneficiary.
4. Separate Accounts:
When multiple heirs are involved, establish separate inherited accounts by December 31 of the year after death so each can use their own life expectancy. Otherwise, all beneficiaries are bound by the oldest person’s shorter expectancy.
5. Penalty Relief:
The IRS penalty for missed RMDs is 25%, but drops to 10% if corrected within two years.
Since every withdrawal from an inherited traditional IRA is taxed as ordinary income, taking large lump-sum distributions can easily push you into a higher tax bracket. Careful timing and planning can make a huge difference.
Key Takeaways and Action Steps
- Identify your beneficiary category immediately—this determines your distribution options.
- Establish separate inherited accounts if multiple heirs are involved to preserve flexibility.
- For beneficiaries in Case B, use the longer life expectancy (yours or the deceased’s) to calculate RMDs.
- Don’t forget the year-of-death RMD if the account owner hadn’t taken it yet.
- Plan withdrawals strategically to manage taxes—avoid letting income pile up in year 10.
- Consider professional guidance—a financial or tax advisor can ensure compliance with the latest IRS regulations and prevent unnecessary penalties.
Final Thoughts
Inheriting a traditional retirement account can be both a blessing and a burden. The new 2025 rules have made the process more structured but also more nuanced. The way you manage distributions directly affects how much of the inheritance you keep after taxes.
By understanding whether you’re under the 5-year, 10-year, or life-expectancy rule—and by carefully planning the timing of your withdrawals—you can preserve your inheritance’s value, minimize taxes, and avoid costly penalties.
Proper estate planning, accurate record-keeping, and timely action can turn a potentially confusing inheritance into a well-managed financial asset for your future.
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