Your IRA, Your Legacy: What Really Happens to IRA Accounts After Death

Most of us think of retirement accounts as something we will use someday. But what happens when someday never comes, and those accounts become part of the legacy we leave behind?

Whether it is a Roth IRA built from decades of disciplined saving or a traditional IRA rolled over from an old employer, these accounts do not just hold dollars. They hold intention. And when we are gone, knowing the rules that govern them can make the difference between a smooth transition and a tax-time tangle for our loved ones.

Let’s walk through what really happens to your retirement accounts after death and how to make sure the people you care about inherit not just your money, but your foresight.

The Basics: Traditional vs. Roth IRAs

Traditional IRA

You contributed pre-tax dollars, received a deduction, and the funds grew tax deferred. That means withdrawals, including those made by your heirs, are taxable as ordinary income. If any non-deductible contributions were made (for example, because your income exceeded the limit for a deduction), those contributions create tax basis in the IRA. Upon withdrawal, the portion attributable to basis is tax-free, while the remaining portion representing pre-tax contributions and earnings is taxable as ordinary income. While the owner is alive, these accounts can be subject to Required Minimum Distributions (RMD) based upon the owner’s age.

Roth IRA

You contributed after-tax dollars, so qualified withdrawals are tax-free. The original owner never had to take RMDs, but beneficiaries still have rules to follow.

Who You Name as Beneficiary Matters

An IRA does not pass under your will or a living trust. It passes by beneficiary designation.
That is why keeping beneficiary designation forms updated after major life changes such as marriage, divorce or death is crucial.

There are two broad categories of beneficiaries:

• Designated Beneficiaries: People, such as your spouse, children or friends.
• Non-Designated Beneficiaries: Entities, such as your estate, a charity or certain types of trusts.

Each category faces different distribution rules.

The SECURE Act and the 10-Year Rule

Congress made a sweeping change to retirement account inheritance rules with the Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed in December 2019 and effective for deaths after January 1, 2020.

Before this law, most non-spouse beneficiaries could stretch withdrawals from an inherited IRA over their own life expectancy, allowing decades of continued tax-deferred or tax-free growth. The SECURE Act largely ended that option.

Under the new law, most beneficiaries must follow the 10-year rule. The inherited IRA must be fully distributed within 10 years after the original owner’s death.

The 10-Year Rule in Practice

If the original account owner had already begun taking RMDs before death, the beneficiary must continue taking annual RMDs, based on IRS life expectancy tables, unless an exception applies (see below). The entire balance must still be withdrawn within 10 years of the owner’s death.

Please note: IRS waived this requirement for beneficiaries subject to the 10-year rule for 2020-2024.

If the account owner had not yet started to receive RMDs, most non-spouse beneficiaries are not required to take annual distributions; however, the entire account must still be fully distributed by December 31 of the 10th year following the owner’s death.

Eligible Designated Beneficiaries (EDBs)

The 10-Year rule does not apply to a small group of beneficiaries called Eligible Designated Beneficiaries, so they can still stretch withdrawals over their own life expectancy:

• Surviving spouses
• Minor children (until they reach the age of majority)
• Disabled or chronically ill individuals
• Beneficiaries that are less than 10 years younger than the decedent

The 5-Year Rule

Not every inherited account qualifies for the 10-Year rule discussed above.

If the account owner died before January 1, 2020, or if the beneficiary is an estate or charity, the 5-Year rule generally applies. Under this rule, the entire account must be distributed by December 31 of the fifth year following death. If the owner had already begun RMDs before death, annual withdrawals must continue based on the IRS life expectancy tables.

Tax Trade-Offs to Consider

For most beneficiaries, the SECURE Act’s 10-Year and 5-Year rules allow income to be spread over time, helping smooth the tax impact. Taking all funds in a shorter duration can increase the tax burden earlier on.

For trust beneficiaries, keeping a trust open can grow the account but may increase administrative and fiduciary costs.

Balancing timing, taxes and practicality is the key.

Roth IRAs: Still Tax-Free, But Not Timeless

Roth IRAs are attractive because beneficiaries generally do not pay income tax on withdrawals. However, the 10-year rule still applies for most non-spouse heirs.

Spousal Flexibility: The Gold Standard of IRA Inheritance

Spouses receive the best options:

1. Treat as their own by rolling it into their own IRA.
2. Keep it as an inherited IRA and possibly defer withdrawals until the deceased would have turned 73.
3. Convert it to a Roth IRA for long-term tax planning, but this would be a taxable event.

This flexibility often makes naming a spouse as the primary beneficiary a powerful strategy, with children or a trust as contingent beneficiaries. These rules apply no matter when the IRA was inherited, though distribution options vary under today’s SECURE Act rules.

When a Trust or Estate Is the Beneficiary

Sometimes people name trusts as beneficiaries of their IRAs instead of individuals to protect young beneficiaries, shield assets from creditors or coordinate with broader estate-plan goals. This can offer significant advantages if the trust meets the IRS rules for a see-through trust (stay tuned for an upcoming article on see-through trusts).

The Double Tax Trap and the IRD Deduction That Fixes It

When a loved one passes away with a Traditional IRA, there is often a hidden surprise: two layers of tax.

1. Estate tax – The IRA’s full value is included in the decedent’s estate.
2. Income tax – When the beneficiary later withdraws funds, those withdrawals are taxed again as ordinary income.

That is a classic case of double taxation, but the tax code offers a quiet remedy called the Income in Respect of a Decedent (IRD) deduction.

If federal estate tax was paid on an IRA or any other IRD asset, the beneficiary who later reports that income can claim an income-tax deduction for the portion of estate tax attributable to that income.

The deduction directly offsets the income on the beneficiary’s tax return.

No Step-Up in Basis for IRAs and Roths

Unlike stocks or real estate, retirement accounts do not receive a step-up in tax basis (to market value) at the owner’s death.

Traditional IRAs remain fully taxable as ordinary income when withdrawn, and Roth IRAs remain tax-free, if qualified. Executors must still report the full date of death value for estate tax purposes, but beneficiaries inherit the built-in tax liability, not a reset basis.

Even though there is no step-up, a precise date of death valuation is essential for estate tax reporting and IRD deduction tracking.

Practical Planning Tips

• Review beneficiary designations every one to two years.
• Name contingent beneficiaries.
• Avoid naming your estate as a beneficiary of your retirement plan.
• Coordinate IRA beneficiary designations with your estate plan, particularly if the named beneficiary is an estate, charity or a trust.
• Consider Roth conversions during your lifetime to reduce potential income tax burdens on heirs.

Whether you are naming beneficiaries or serving as an executor, the rules change frequently, so it is worth revisiting your plan each year with your tax advisor.

Final Thoughts: The Power of Getting It Right

Retirement accounts can be among the most valuable and most misunderstood assets in an estate. The rules are complex, the timing strict and the tax impact enormous.

With careful planning, you can turn confusion into clarity. The right structure can preserve more of what you have built, reduce stress for your loved ones and ensure your legacy unfolds exactly as you intended.

These rules are complicated and can significantly affect your overall tax and estate plan. Please contact us to discuss your goals, review your options and help ensure a strategy that benefits you and your heirs.

 

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