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Retirement Planning > Saving for Retirement > IRAs

How Secure Act's 10-Year Rule Creates Tax Headaches for IRA Heirs

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What You Need to Know

  • Clients should reconsider beneficiary designations to ensure their accounts pass to heirs in the most tax-efficient way possible.
  • If the IRA beneficiary is not an EDB, the account must generally be emptied within 10 years.
  • Even if the beneficiary complies with the 10-year rule, each distribution will increase the beneficiary’s taxable income.

The Setting Every Community Up for Retirement Enhancement (Secure) Act fundamentally changed the rules governing distributions from inherited retirement accounts mere months before the COVID-19 pandemic struck the U.S. Understandably, many clients put those new rules on the back burner to focus on more pressing concerns, but now clients should be reminded about the changes.

The post-Secure Act distribution requirements mean that clients should reconsider their beneficiary designations to ensure that their accounts are passed down to heirs in the most tax-efficient manner possible.

Inheriting an IRA or 401(k) under the new regime can create a number of adverse tax consequences for the beneficiary — and it’s never too early to take actions designed to ensure the best possible outcome from a tax perspective.

Post-Secure Act Distribution Rules

For clients who inherit traditional retirement accounts after Dec. 31, 2019, the “stretch” inherited IRA strategy has been sharply limited. Under the Secure Act, nearly every beneficiary who inherits a retirement account (IRAs, 401(k)s, etc.) in 2020 and beyond will have to empty the account within 10 years — and pay income tax on the distribution at ordinary income tax rates. 

Generally speaking, if the IRA beneficiary is not an “eligible designated beneficiary,” the entire account must be emptied within 10 years. Eligible designated beneficiaries (EDBs) include spouses, disabled and chronically ill beneficiaries, minor children of the account owner and beneficiaries who are less than 10 years younger than the owner. EDBs are exempt from the new rules — and can continue to empty the inherited account by taking distributions over their own life expectancy (and can stretch the tax liability over that time period).

Beneficiaries who are subject to the 10-year rule should not be required to take a distribution every year (i.e., the beneficiary can still defer taxes for 10 years and take a lump-sum distribution at the end of that period). 

Understanding the Consequences of the 10-Year Rule

The first major tax consequence of the new Secure Act inherited account rule is the penalty for noncompliance. Although the beneficiary can use discretion in determining when to take distributions within the 10-year time frame, if the beneficiary fails to empty the account within 10 years, the IRS imposes a 50% penalty on the amount remaining in the account.

There are, of course, a number of indirect consequences that apply even if the beneficiary complies with the 10-year distribution rule. Every distribution will increase the beneficiary’s taxable income for the year.

That creates the possibility that the beneficiary could jump into a higher tax bracket — which would apply to all income across the board.

It’s also possible that the increase in taxable income could make it more difficult to obtain financial aid for college. Retirement account owners often name their children as beneficiaries. Grown children are subject to the 10-year distribution rule — and it’s possible that their own children may be applying for college financial aid during the 10-year window. While the amount that remains in the account won’t be counted in determining financial aid, any distribution is treated as income and will count.

Medicare premiums can also be affected by an increase in taxable income. Income-based surcharges are added onto the base Medicare premium for taxpayers with higher incomes. Because an inherited account distribution increases taxable income, it can also cause the recipient to become subject to the surcharges — remembering that a two-year lookback rule applies so that it’s the taxpayer’s income at age 63 that determines Medicare premium amounts at age 65.

Potential Solutions

Every beneficiary should examine their own tax picture in determining the best course of action when it comes to distributions within the 10-year window. 

Current account owners, however, should take action to minimize the tax implications for their beneficiaries. Clients with multiple heirs may wish to leave the traditional retirement account to someone who qualifies as an EDB or who is in a lower income tax bracket.

For many account owners, executing a Roth conversion strategy can add flexibility and minimize the amounts in traditional retirement accounts. While Roth IRAs are subject to the new 10-year distribution rule, distributions aren’t counted as taxable income when the beneficiary eventually withdraws the funds.

Taxpayers interested in a Roth conversion strategy should act quickly. Current tax rates are historically low — and it’s widely anticipated that at least some taxpayers will see a tax increase under the Biden administration in the coming year.


Planning for inherited IRAs and 401(k)s has become more complex than ever under the Secure Act. Taxpayers have options for limiting their tax exposure and should be advised to examine the options sooner rather than later.


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