Inheritance Laws: The End of the Stretch IRA and Your Strategy

Inheriting an Individual Retirement Account (IRA) used to be a straightforward way to build long-term wealth, but recent legislation has completely altered the playbook. If you stand to inherit a retirement account, or if you plan to leave one behind, the old rules no longer apply. The SECURE Act and its successor, SECURE 2.0, have effectively eliminated the “Stretch IRA” for most beneficiaries. This shift forces heirs to withdraw funds much faster, often resulting in significantly higher tax bills.

The Death of the Stretch IRA

For decades, the “Stretch IRA” was a popular estate planning strategy. It allowed a non-spouse beneficiary, such as a child or grandchild, to inherit an IRA and extend the required minimum distributions (RMDs) over their own life expectancy. If a 40-year-old inherited an account, they could stretch small, tax-efficient withdrawals over 40+ years. This allowed the remaining money to grow tax-deferred for decades.

The SECURE Act of 2019 changed this for anyone passing away after December 31, 2019. The new law introduced the 10-Year Rule.

Under this rule, most non-spouse beneficiaries must deplete the entire inherited retirement account by the end of the 10th year following the year of the account owner’s death. There is no longer a lifetime of tax-deferred growth. The IRS wants its tax revenue sooner rather than later.

Understanding the 10-Year Rule

The 10-year rule seems simple on the surface, but the application is nuanced. The rule applies to both traditional IRAs and Roth IRAs, though the tax implications differ.

For Traditional IRAs

You must withdraw all assets by December 31 of the 10th year after the death. However, when you take that money during the 10-year window depends on whether the original owner had already started taking their RMDs.

If the owner died BEFORE their Required Beginning Date: You generally do not have to take annual distributions. You can let the money sit and grow for ten years, then withdraw the full lump sum at the very end.
If the owner died AFTER their Required Beginning Date: This is where confusion has occurred. The IRS proposed regulations indicating that beneficiaries must take annual RMDs for years 1 through 9 and empty the account in year 10.

Due to confusion over this “at least as rapidly” rule, the IRS issued Notice 2024-35. This notice waived penalties for beneficiaries who failed to take these annual RMDs in 2021, 2022, 2023, and 2024. However, you should anticipate that annual withdrawals will be enforced starting in 2025.

For Roth IRAs

Inherited Roth IRAs are also subject to the 10-year rule. However, because Roth distributions are tax-free, the strategy is much simpler. Since you do not owe taxes on the withdrawals, it almost always makes sense to leave the money in the account for the full 10 years. This allows the investments to grow tax-free for a decade before you withdraw the lump sum at the deadline.

Exceptions: Eligible Designated Beneficiaries

Not everyone is subject to the strict 10-year timeline. Congress created a category called Eligible Designated Beneficiaries (EDBs) who can still stretch distributions over their lifetime.

You qualify as an EDB if you are:

A surviving spouse: You can treat the IRA as your own or take distributions over your life expectancy.
A minor child of the account owner: You can stretch payments only until you reach the age of majority (defined as age 21 for this specific IRS rule). Once the child turns 21, the 10-year clock starts, and the account must be empty by age 31.
Disabled or chronically ill: Must meet strict IRS definitions of disability.
Individuals not more than 10 years younger than the deceased: For example, a sibling or partner who is close in age to the account owner.

Strategic Planning for the New Reality

With the loss of the lifetime stretch, you need specific strategies to minimize the tax hit. If a beneficiary inherits a $500,000 IRA and has to withdraw it over 10 years, that adds $50,000 to their taxable income every year. This could easily push them into a higher tax bracket (e.g., jumping from the 22% bracket to the 24% or 32% bracket).

Here are three ways to manage this liability:

1. Roth Conversions During Your Lifetime

If you are the account owner, consider converting traditional IRA funds to a Roth IRA while you are alive. You will pay the taxes now, likely at a lower rate than your heirs would pay later. When your heirs inherit the Roth, they still have to empty it in 10 years, but every penny they withdraw will be tax-free.

2. Life Insurance Replacement

Some families are opting to withdraw funds from their IRAs to pay premiums on a permanent life insurance policy. Upon death, the heirs receive the life insurance payout. Life insurance proceeds are generally income-tax-free and are not subject to the 10-year distribution rule. This effectively “stretches” the wealth again, bypassing the SECURE Act restrictions.

3. Charitable Remainder Trusts (CRTs)

For large estates, a Charitable Remainder Trust can simulate the old Stretch IRA. You name the trust as the beneficiary of the IRA. When you die, the IRA moves into the trust tax-free. The trust then pays your heir a percentage of the assets annually for a set term or for life. When the heir dies or the term ends, the remaining money goes to a designated charity. This provides a lifetime income stream for the heir, though it requires complex legal setup and administration costs.

Frequently Asked Questions

What is the penalty for missing a distribution?

SECURE 2.0 reduced the penalty for failing to take an RMD. It used to be a massive 50% of the amount not withdrawn. Now, the penalty is 25%. If you correct the error promptly (generally within two years), the penalty is further reduced to 10%.

Do the new rules apply to IRAs inherited before 2020?

No. If you inherited an IRA from someone who died on or before December 31, 2019, you are “grandfathered” in. You can continue to stretch your distributions over your lifetime according to the old rules.

Can I just cash out the inherited IRA immediately?

Yes. You always have the option to withdraw the full balance immediately. However, for a traditional IRA, the entire amount will be added to your taxable income for that year. This often results in the highest possible tax bill, so financial planners rarely recommend it unless the account balance is very small.

How does the minor child rule work for grandchildren?

This is a common point of confusion. The exception for minor children applies only to the direct children of the account owner. It does not apply to grandchildren. If you leave an IRA to a minor grandchild, they are subject to the 10-year rule immediately, regardless of their age.