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You May Need to Drain Your Inherited IRA Sooner Than You Think

You May Need to Drain Your Inherited IRA Sooner Than You Think

July 11, 2022

Impact of Proposed IRS Changes on Inherited Retirement Accounts

The IRS has a proposal pending that could be a big deal for heirs inheriting retirement accounts.

Heirs who received retirement accounts used to have the option to spend down the account throughout their lifetime. For younger heirs especially, this was a great benefit because the inheritance got to grow tax-deferred for a much longer time.

In 2019, lawmakers shook up the way tax-deferred retirement accounts can be passed on. Now, heirs who aren’t spouses, disabled, chronically ill, minor children or more than 10 years younger than the IRA owner must drain the accounts within 10 years of the original owner’s death. If a controversial proposal by the Internal Revenue Service passes muster, they’ll also have to take minimum distributions in years one through nine, instead of waiting until the 10th year to zero things out — a further crimp to appreciation and long-term wealth building.

It sounds restrictive, and it’s the biggest change to retirement plans in more than a decade. But for some heirs, the 10-year window may actually be five.

Understanding the 10-Year Rule: Implications for Heirs and Estate Planning

It’s all due to a gray area in the new law, the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The 2019 law doesn’t explain what happens when a taxpayer doesn’t indicate to the IRS’s satisfaction who their beneficiary is.

Internal revenue service

If you plan to leave a retirement account to your heirs, or if you expect to inherit one, it makes a lot of sense to consult with your estate planning attorney to see what restrictions apply in your case.

Five years

The 10-year rule hits retirement accounts inherited from people who passed away on or after January 1, 2020. And for some, they may be required to empty the retirement account in only five years.

IRS rules that pre-date the SECURE Act say that if a taxpayer dies before beginning required minimum distributions, typically at age 72, and hasn’t specified who will inherit their IRA or 401(k), then the account goes into the deceased’s estate. The estate’s heir or heirs then have five years to drain the account. The five-year rule also applies to inherited Roth IRAs in existence for less than five years. And it applies to some beneficiaries who inherit a retirement plan through a so-called beneficiary account, like a trust.

Navigating Tax Implications and Trust Structures for Inherited Retirement Accounts

Under those prior IRS rules, the beneficiary of an estate planning vehicle known as a “see-through” trust is treated as if she directly inherits the trust’s assets, even as the vehicle is technically the beneficiary. The IRS “looks through” the trust to see that an actual human being — the trust’s beneficiary — is there. Before the 2019 law, those people could stretch out withdrawals over their lifetime. Now, depending on whether the trust is properly set up, the 10-year deadline could be five years.

That's in part because IRS rules for see-through trusts are strict. Along with record-keeping requirements, the tax agency requires that the vehicles be irrevocable, valid, and legal in the state where they’re set up and clear about the identity of their beneficiaries. If a trust doesn't meet those requirements, beneficiaries can be required to drain them in five years.

The issue is that the SECURE Act doesn’t spell out whether its 10-year rule applies to see-through trusts. Nor has the IRS offered guidance on the issue. If the rule doesn’t apply, then some beneficiaries of those trusts might have to empty out an IRA within five years as before — an outflow that can spike an heir’s income and tax rate.

Because trusts have their own special tax rules, the five-year window can quickly become expensive. Distributions from trusts are taxed as ordinary income, but at trust income tax rates which are generally higher than income tax rates for individuals.

For example, taxpayers making at least $539,900 ($647,850 for married couples) pay the top individual tax rate of 37% on their income. But for trust income, that top rate kicks in at only $13,450.

Wealthy taxpayers like see-through trusts because they allow them to control how their retirement plans will be used by heirs once they die. By bequeathing an IRA to a trust, instead of to an individual heir, the owner can ensure through the trust’s language and terms that the funds won’t be spent on fancy cars and expensive vacations.

If you think you might have a larger retirement plan to leave to an heir, or if you think you might inherit somebody’s retirement plan, it pays to talk with an estate planning expert. Generally, the people who end up getting burned by the five-year rule are folks who chose to do their own estate documents and not use a professional. It can be a costly choice.

If you are not sure about your situation and would like to talk with me, I would be honored to be of assistance. Follow this LINK to find a time for us to talk. As a

CERTIFIED FINANCIAL PLANNER™ professional, I’m always an advocate for my clients’ best interests. I’m happy to help you sort things out.

To find a CFP® professional near you, start your search here.

As you visit with financial planners, I suggest a couple of things to check:

  • Is the advisor always the client’s advocate – a fiduciary advisor?
  • Is the advisor paid by clients, not financial product manufacturer or distribution network? That would be a fee-only advisor.

These two points help assure that you are working with a professional who is committed to your best interest at all times. It seems sort of obvious to me that a professional would work in this way, but it’s not automatic.

A fiduciary, fee-first, CFP® professional can help you make great retirement income choices and develop a comprehensive financial plan that is driven by your goals and priorities and addresses all aspects of your financial life. With a big-picture approach, you will be better prepared to understand your options at every step along the way.

Yes, I am a CFP® professional. I’m always a fiduciary and I work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice. 

If this article has you thinking about your own circumstances, contact my office at I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.