THE INHERITED IRA TAX TRAP
What the SECURE Act means for your clients' heirs
Over the next two decades, the United States will see the largest generational wealth transfer in its history — an estimated $84 trillion moving from the Silent Generation and Baby Boomers to Gen X, Millennials, and Gen Z through 2045. A significant share of that wealth sits in qualified retirement accounts: IRAs, 401(k)s, and other tax-deferred vehicles.
For advisors, that means one thing: even if you never get another new client, your existing clients' children are likely going to inherit these accounts — and inherit a tax problem along with them.
The stretch IRA is gone
Before 2020, a non-spouse beneficiary who inherited an IRA could “stretch” distributions over their own life expectancy, spreading the tax hit across decades. The SECURE Act eliminated that option for many beneficiaries. Today, most non-spouse heirs must fully distribute an inherited IRA within 10 years — and depending on the original owner's age and RMD status, may owe distributions in most or all of those years, or face a penalty.
Notably, the SECURE Act took effect at the start of 2020 — the same moment COVID-19 dominated every headline in the country. Little wonder so many advisors, and even more clients, never fully registered how much the rules had changed.
What a 10-year payout could actually cost a beneficiary
Consider a hypothetical: Karen, age 50, lives in Wisconsin and earns $150,000 a year. On her current income alone, she nets about $98,125 after federal, state, and Medicare taxes.
Now Karen inherits $1 million in a traditional IRA. Spread over 10 years, that'sroughly $100,000 in additional taxable income annually — pushing her total income to $250,000 a year and into meaningfully higher tax brackets.
The result: her take-home pay increases by only about $37,950 a year, not the full $100,000. A large share of the inheritance is absorbed by taxes precisely because it's layered on top of her existing earned income.
This is the “do-nothing” scenario — and it'slikely the default outcome for any client who never plans for what happens after the inherited IRA arrives.
Why this problem will get worse
Historically, the U.S. is sitting near the lower end of its long-run tax rate range. Most planning-minded clients already expect rates to rise over the coming years and decades. If they do, the math above only gets worse: beneficiaries forced into mandatory 10-year distributions will hand over an even larger share of their inheritance in taxes, with less control over timing than the stretch IRA rules used to allow.
Why “do nothing” is the default — and usually the problem
Most CPAs are excellent at reporting on the taxes a client already owes, but they aren't typically in the business of proactive, multi-decade tax strategy. And most annuity carriers won't even accept inherited IRA assets, in part because of the penalty exposure involved. Absent a deliberate plan, the most common outcome is typically like the one Karen faces: full exposure to the 10-year distribution rule, taxed at whatever bracket the extra income pushes the beneficiary into.
The planning opportunity
None of this means the situation is unsolvable — it means it requires a strategy built specifically around the 10-year distribution window, rather than a passive “just pay the taxes” approach. There are ways to help structure distributions, and to reposition the after-tax proceeds, that meaningfully change the outcome for a beneficiary like Karen.
We walk through one such strategy — using the same distributed assets to fund a properly structured, tax-advantaged vehicle — in our companion article:Turning an inherited IRA into tax-free wealth.
Talk to Peak Pro Financial
If your clients have substantial qualified assets, the question isn't just who will inherit them. It's how much of that inheritance will actually make it to the next generation.Let's talk about how the SECURE Act's 10-year rule could affect your clients' heirs and what planning opportunities may exist before the assets are distributed.
Reach out to Peak Pro Financial. Because waiting until the inherited IRA arrives may leave the beneficiary with fewer options and a much bigger tax bill.
Learn more about PATH, one of Peak Pro Financial's tax-efficient legacy strategies for high-net-worth clients..
Or call us at 866.866.7050
This article is based on a Peak Pro Financial webinar, “Solving the Inherited IRA Dilemma,” presented by Nick Lowett, VP of Sales and Development.
The example above is hypothetical and illustrative only, based on stated assumptions about income, filing status, and current tax law. It is not a projection or guarantee for any individual, and tax outcomes vary by state, income, and circumstances. Consult a qualified tax professional before making decisions about an inherited retirement account.
