The 10-Year Inheritance Clock: Why IRA Tax Planning Should Start Early

The 10-Year Inheritance Clock: Why IRA Tax Planning Should Start Early

CRAIG LOKEN, ASSOCIATE PORTFOLIO MANAGER

For many families, retirement accounts are one of the largest assets passed from one generation to the next. But unlike a house, checking account, or taxable investment account, a traditional IRA often comes with a tax bill attached. 

That does not make an IRA a bad asset to inherit. It simply means the planning may not end with the original IRA owner. 

Under current rules, many non-spouse beneficiaries must fully distribute an inherited IRA by the end of the 10th year after the original owner’s death. Depending on the original owner’s age and required minimum distribution status, annual beneficiary distributions may also be required. Spouses and certain eligible designated beneficiaries may have different options.
The challenge is timing. A child inheriting a traditional IRA in their 40s or 50s may already be in peak earning years, raising children, paying a mortgage, and building a career. Add inherited IRA distributions, and the inheritance may push additional income into higher tax brackets.
That is where Roth conversions can enter the conversation. 

Roth Conversions: Paying Tax with Intention
A Roth conversion moves money from a traditional IRA into a Roth IRA. The converted amount is generally taxable in the year of conversion, but future qualified Roth IRA withdrawals may be tax-free if certain requirements are met. 

Said another way, the question is not always whether tax will be paid. The question is who pays it, when they pay it, and at what rate. 

If a retired IRA owner is in a lower tax bracket than future beneficiaries, partial Roth conversions over several years may reduce the amount of taxable IRA money eventually passed to loved ones. This can be especially useful when heirs are likely to inherit during high-income years. 

The Medicare Caveat
Roth conversions are not free tax planning magic. For retirees on Medicare, conversion income can also affect premiums through IRMAA, the Income-Related Monthly Adjustment Amount for higher-income Medicare beneficiaries. 

Avoiding IRMAA should not automatically stop a Roth conversion, but it should be part of the calculation. Sometimes paying a higher Medicare premium for a year may still be worthwhile. In other cases, the conversion may be better reduced or spread over several years. 

Think in Brackets, Not Just Balances
A large IRA is a sign of discipline and delayed gratification, but retirement planning is not only about how much is in the account. It is also about what future distributions may look like and how those distributions may affect the next generation. 

A thoughtful plan may ask:
Should IRA distributions begin before required minimum distributions?

• Would partial Roth conversions make sense during lower-income retirement years?
• Are beneficiaries likely to be in higher tax brackets?
• Could inherited IRA distributions create tax pressure for the next generation?
• Would charitable giving strategies help reduce taxable IRA balances?
• How close is the current owner to an IRMAA threshold? 

The Bottom Line
The 10-year inherited IRA rule changed the way many families should think about retirement accounts. It does not mean everyone should rush into Roth conversions. It does mean IRA owners should think beyond their own retirement income and consider how their accounts may affect the next generation. 

For families with significant traditional IRA assets, the best time to review the plan is often before the inheritance clock starts ticking.