Did you inherit an IRA? Do This First.

If you just inherited an IRA, the inherited IRA rules are less forgiving than most people expect. One wrong move in the first 12 months could cost you tens of thousands of dollars in taxes and trigger an IRS penalty equal to 25% of what you should have taken out.

This article covers how an inherited IRA works, how a traditional account differs from a Roth, the 10 year rule, and how to decide when to take the money out.

What is an inherited IRA?

When someone passes away with a retirement account, whether an IRA, a 401(k), or a 403(b), that account does not become yours the way a checking account would. It becomes what the IRS calls an inherited IRA. It has to be retitled, and it cannot be merged into your own retirement accounts.

You cannot wait until you are 73 to start distributions the way you would with your own IRA. The clock starts when the original owner passes away.

Inherited traditional IRA vs inherited Roth IRA

A traditional IRA was funded with pre tax dollars, and the original owner's deal with the IRS was to pay the tax on the way out. That tax bill transferred to you. Every dollar you withdraw is taxed as ordinary income in the year you take it, stacked on top of your other income.

With a Roth, the original owner already paid the tax. As long as the account has been open for at least 5 years by the time you take distributions, what comes out is tax free. An inherited Roth still has a deadline, usually 10 years, so the goal is to keep the tax free growth going as long as the rules allow, which usually means waiting until year 10.

How the 10 year rule works for inherited IRAs

The 10 year rule came from the SECURE Act in 2020. If the original owner passed away in 2020 or later and you do not fit an exception, the entire account has to be emptied by December 31 of the 10th year after the year of death. That covers most adult children inheriting from a parent.

The catch is that if the original owner had already started required minimum distributions, you also have to take one every year during that window. Skipping one carries a penalty of 25% of the amount you should have taken, reduced to 10% if you fix it quickly, and the IRS is enforcing it starting in 2025.

Four groups get different treatment:

• Spouses can roll the IRA into their own, which is almost always the right move.
• Minor children of the deceased do not start the 10 year clock until they turn 21.
• Disabled and chronically ill beneficiaries can stretch distributions over their own life expectancy.
• Siblings less than 10 years younger than the deceased can do the same.

When to take money out of an inherited IRA

The answer is neither as soon as possible nor the very last year. It depends on three things.

• Your income. You generally want to pull more in low income years and less in high income years. The window after you stop working but before Social Security and required minimum distributions begin is often a good time to take larger amounts. If you expect to stay a high earner for the decade, spreading distributions evenly across all 10 years may keep you out of the 32% or 35% federal bracket.
• Where you live. In states like California, New Jersey, or New York, state tax could add 9%, 10%, or even 13% on top of federal. If a move to a state with no income tax is real and not hypothetical, delaying distributions until you have established residency can make sense.
• Your need for the cash. If you do not need the money to live on, you can plan around tax brackets, Roth conversions, and capital gains harvesting. If you do need it, liquidity matters more than taxes.

A rule of thumb I share with clients: project your taxable income for each of the next 10 years, find the years where you are clearly in a lower bracket, and front load distributions into those years until you are about to cross into the next bracket up.

Inherited IRA mistakes to avoid

• Rolling an inherited IRA into your own IRA when you are not a spouse. The IRS treats the entire account as a taxable distribution in one year, and it is irreversible.
• Taking everything out in year 1 because the bank told you to. A lump sum can easily double your tax bill.
• Naming your estate as beneficiary instead of a person. An inherited IRA that passes through an estate often loses the 10 year window and gets a 5 year rule instead.

Common questions

Do I pay taxes on an inherited IRA?

On a traditional inherited IRA, yes. The full distribution is added to your taxable income for that year. There is no automatic withholding unless you ask for it, and I usually recommend asking.

Can I roll an inherited IRA into my own IRA?

Only if you are the surviving spouse.

Should I get help before taking a distribution from an inherited IRA?

If the account is large, say over $100,000, your tax situation is complicated, or there are multiple beneficiaries, talk to a fee only financial advisor or a CPA first.

VDB Wealth is a registered investment adviser. Information presented is for educational purposes only and is not intended to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Past performance is not indicative of future performance.

If you just inherited an IRA, there is a very real chance that one wrong move in the next twelve months could cost you tens of thousands of dollars in taxes, trigger an IRS penalty equal to twenty five percent of what you should have taken out, and quietly push you into a tax bracket you have never been in before. And the worst part? Your bank, your brokerage, and even the person who left it to you almost certainly never warned you about any of it.

The stakes and the promise

I am going to walk you through exactly how inherited IRAs work, the critical difference between a traditional inherited IRA and an inherited Roth, the ten year rule that trips up almost everybody, and most importantly, how to figure out the smartest year, or years, to actually pull the money out based on your income, where you live, and what you actually need the cash for. Stick with me, because the decision you make in the first eighteen months after inheriting one of these accounts will quietly shape your tax bill for the next decade. I am a financial advisor, this is what I do every day for families, and by the end of this video you are going to understand inherited IRAs better than ninety percent of the people who own one.

Who this is for

Before we dive in, I want to acknowledge something. If you are watching this, you probably just lost a parent, a spouse, an aunt, or someone close to you. I am sorry. The last thing you want to think about right now is the IRS. But here is the truth. The tax rules around these accounts are not forgiving, and they do not care that you are grieving. So the kindest thing I can do is help you understand the rules clearly, in plain English, so you can make a calm decision instead of a panicked one. Save this video, send it to a sibling, come back to it. It will still be here.

What an inherited IRA actually is

Let us start at the beginning. When somebody passes away and they had a retirement account, an IRA, a 401k, a 403b, that account does not just become yours like a checking account would. It becomes what the IRS calls an inherited IRA, sometimes called a beneficiary IRA. It has to be retitled. It cannot be merged into your own retirement accounts. It lives in its own separate world with its own separate rulebook.

And here is the first thing almost everybody gets wrong. You cannot just leave the money sitting there forever. You cannot treat it like your own IRA and wait until you are seventy three to start taking distributions. The clock starts ticking the moment the original owner passes away, and depending on who you are and what kind of account it is, that clock runs out faster than you think.

The other thing to understand is that an inherited IRA is not free money. Every dollar you pull out of a traditional inherited IRA is taxed as ordinary income in the year you take it. Not capital gains. Not long term rates. Ordinary income, stacked right on top of your salary, your business income, your social security, everything else. We are going to come back to that, because it is the single most important planning point in this entire video.

Traditional vs Roth, the critical difference

Now let us tackle question number one. What is the difference between inheriting a traditional IRA and inheriting a Roth IRA?

A traditional IRA was funded with pre tax dollars. The person who originally owned it got a tax deduction when they put the money in, the money grew tax deferred for years or decades, and the deal they made with the IRS was simple. Pay the tax on the way out. When they passed away without finishing that deal, that tax bill did not disappear. It transferred to you. So when you pull money out of an inherited traditional IRA, the full amount is taxable to you at your ordinary income tax rate.

A Roth IRA is the opposite. The original owner already paid the tax on that money before it went in. It grew tax free, and as long as the account has been open for at least five years by the time you are taking distributions, every dollar that comes out to you is completely tax free. No federal tax. No state tax. Nothing.

But, and this is the part most people miss, an inherited Roth still has a distribution deadline. You do not get to leave it sitting there compounding tax free for the rest of your life. The IRS still wants that account emptied out, usually within ten years. So even though there is no tax bill, there is still a clock.

The practical takeaway is this. If you inherited a traditional IRA, your job is to manage the tax bill. If you inherited a Roth, your job is to maximize the tax free growth for as long as the rules let you, which usually means waiting until year ten and then pulling it all out at once.

The ten year rule and who it applies to

Okay, the ten year rule. This is the rule that changed everything back in 2020 with the SECURE Act, and then got even more complicated in 2024 and 2025 with new IRS guidance.

Here is the simple version. If you inherited an IRA from someone who passed away in 2020 or later, and you are not the spouse, not a minor child of the deceased, not disabled or chronically ill, and not less than ten years younger than the deceased, then you fall into the category the IRS calls a non eligible designated beneficiary. That is most adult children inheriting from a parent. And if that is you, the entire account has to be emptied by December 31 of the tenth year after the year of death.

So if your parent passed away in 2024, you have until the end of 2034. That sounds like a long runway, and it is, but here is the trap. If the original owner had already started taking required minimum distributions before they passed, the IRS now requires you to also take an annual required minimum distribution every single year during that ten year window, and then empty the account by year ten. You cannot just wait until year ten and pull it all at once. If you skip a required distribution, the penalty is twenty five percent of the amount you should have taken, reduced to ten percent if you fix it quickly.

If you are a spouse inheriting from your husband or wife, you have far more flexibility. You can roll the IRA into your own, and then it just becomes your retirement account, subject to your own timeline. That is almost always the right move for a surviving spouse, but not always, and we will touch on the exception in a moment.

If you are a minor child of the deceased, the ten year clock does not start until you turn twenty one. Disabled and chronically ill beneficiaries can stretch distributions over their own life expectancy. And if you are a sibling who is less than ten years younger than the person who passed, you also get to use your own life expectancy. Those are the four exceptions. Everybody else, ten years.

How distributions actually work mechanically

Let me get practical for a minute. Here is what actually happens.

Step one. The custodian, meaning the brokerage or bank holding the account, sets up a new inherited IRA in your name with the deceased person listed as the original owner. You will see something like, John Smith deceased, for the benefit of Jane Smith.

Step two. You can leave the money invested. Stocks, bonds, mutual funds, whatever was in there can stay in there. You are not forced to liquidate immediately.

Step three. When you take a distribution, the custodian sends you the cash and reports it to the IRS on a form 1099 R. You will get that form the following January. The full amount of the distribution, if it is from a traditional IRA, gets added to your taxable income for that year.

Step four. You owe the tax when you file your return. There is no automatic withholding unless you ask for it, and I usually recommend that you do ask for it, because writing a surprise five figure check in April is nobody's idea of fun.

The big question, when to actually take the money out

Now we get to the part of this video that actually matters most, and the part that nobody on the internet seems to talk about clearly. When should you take the money out?

The answer is not, as soon as possible. The answer is not, wait until the very last year. The answer is, it depends, and here are the three things it depends on.

Factor one, your income

The single biggest variable is what your taxable income looks like in each of the next ten years. Because every dollar you pull out of a traditional inherited IRA gets stacked on top of your other income, you want to pull more in low income years and less in high income years. If you are planning to retire in three years, that retirement window, after you stop working but before social security and required minimum distributions kick in, is often a goldmine. Your income drops, your tax bracket drops, and you can pull large chunks out at a much lower rate than if you had taken it all while you were still working.

If you are a high earner right now and you expect to keep earning at the same level for the next decade, the math gets harder. In that case you may want to spread the distributions evenly across all ten years to avoid bunching everything into one year and accidentally pushing yourself into the thirty two or thirty five percent federal bracket. Even taking small annual distributions every year is usually better than letting it all balloon to year ten.

Factor two, where you live

State income tax matters more than people realize. If you live in California, New Jersey, New York, Oregon, or Minnesota, you could be paying nine, ten, even thirteen percent in state tax on top of federal, and that is on top of any local tax. Compare that to Florida, Texas, Tennessee, Nevada, Washington, Wyoming, South Dakota, or New Hampshire, where there is no state income tax on this kind of income. If you are planning a move to a no income tax state in the next few years, and that move is real and not hypothetical, it can make enormous sense to delay distributions until after you have established residency in the new state. I have personally seen families save fifty to a hundred thousand dollars just by timing distributions around a planned relocation.

The flip side is also true. If you are planning to move from a low tax state to a high tax state, you may want to accelerate distributions before the move.

Factor three, your actual need for the cash

This sounds obvious but it gets overlooked. If you do not need the money to live on, you have flexibility, and flexibility is valuable. You can plan around tax brackets, you can plan around Roth conversions, you can plan around capital gains harvesting. If you do need the money, say to pay off a mortgage, fund a kid's college, start a business, or cover medical expenses, then the conversation shifts from minimizing taxes to making sure you actually have the cash when you need it. Taxes matter, but liquidity matters more. Do not let tax optimization talk you out of using money you genuinely need.

A useful rule of thumb I share with clients is this. Project your taxable income for each of the next ten years. Identify the years where you are clearly in a lower bracket. Front load distributions into those low years until you are about to cross into the next bracket up, and then stop. It is boring math, but it works, and it usually saves real money.

Common mistakes to avoid

Quickly, here are the mistakes I see over and over.

One, rolling an inherited IRA into your own IRA when you are not a spouse. You cannot do this. If you do it, the IRS treats the entire account as a taxable distribution in one year. It is one of the most expensive mistakes in personal finance and it is irreversible.

Two, taking the whole thing out in year one because the bank told you to. Banks are not tax advisors. A lump sum distribution can easily double your tax bill compared to spreading it out.

Three, ignoring the annual required minimum distribution if the original owner was already taking them. The IRS waived the penalty for a few years while everybody figured out the new rules, but starting in 2025 they are enforcing it. Do not assume you can skip years.

Four, forgetting about state tax. Federal is only part of the picture.

Five, naming your estate as the beneficiary instead of a person. If an inherited IRA passes through an estate, you often lose the ten year window and get stuck with a five year rule instead. Always make sure beneficiaries are named directly on the account.

When to get help

Look, I made this video to give you a real foundation, not to replace personalized advice. If the inherited account is large, say over a hundred thousand dollars, or if your tax situation is complicated, or if there are multiple beneficiaries, or if you are not sure whether the original owner had started required minimum distributions, please talk to a fee only financial advisor or a CPA before you take any distribution. One conversation can save you years of regret. And if you do not have somebody you trust, that is part of what we do at our firm, and there is a link in the description if you want to reach out.

Closing

Inherited IRAs are one of those topics where the rules feel small and technical, but the dollar amounts are enormous. The difference between a thoughtful ten year distribution plan and a panic driven decision can easily be the cost of a new car, a down payment on a house, or a year of college tuition. So take your time, run the numbers, and make the decision you will be proud of in ten years.

If this video helped you, do me a favor and hit the like button, it genuinely helps the channel, and subscribe so I can keep making videos like this for you. Drop your questions in the comments. I read them, and the best ones turn into future videos. Thanks for watching, and I will see you in the next one.