How Your IRA Beneficiary Choice Affects Inheritance Taxes

IRAs are among the most common investment accounts in America. This means that deciding who inherits an IRA is a question many families will face.

With the passage of the SECURE Act in 2019 and its follow-up, SECURE 2.0, in 2022, the rules around inherited IRAs became more complex. The IRS issued guidance in July 2024 that clarified how and when heirs must take IRS distributions.

At the heart of it all is one critical decision: Who should you name as your IRA beneficiary? 

Why does it matter who I name as my IRA beneficiary?

When people think about estate planning, they often focus on the big picture - leaving everything to a spouse, dividing assets among children, passing wealth to future generations, including a charitable beneficiary for a portion of your estate, etc.  But from an income tax planning perspective, the details of how specific accounts (especially IRAs) pass to your heirs can have a significant impact on what your heirs can keep, after paying taxes. 

The tax consequences vary widely depending on who you name as Beneficiary.   

How does my IRA beneficiary choice affect when and how the money gets taxed?

When you leave behind an IRA, eventually your beneficiary will need to take that money out of the account. But who takes it out and when it gets taken out can make a profound difference in how much they get to keep after taxes. 

IRA withdrawals are considered “ordinary income” within the Tax Code, and are typically subject to the highest of the income tax rates.  If your IRA beneficiary takes large distributions from the account in years when they have high taxable income (maybe because they’re still working, or sell a property, etc.) they could get pushed into a higher-than-normal tax bracket, meaning more of that inheritance goes to taxes. 

Timing the withdrawals (to the extent possible) can be structured to: 

• Spread the income over lower-income years, like after retirement or in between jobs. 

• Coordinate with Roth conversions to move money into tax-free accounts over time. 

• Avoid overlapping large withdrawals with other taxable events, like large capital gain years or Social Security claiming before age 70. 

The more time your beneficiary has to plan (which could be 5 years, 10 years, or a lifetime), the more flexibility they’ll have to reduce taxes and preserve your gift.  

What are the different types of IRA beneficiaries and how do the rules vary?

Inherited IRA distribution rules vary depending on who you name as Beneficiary. These rules get very complicated, so we’re not going to run through every potential iteration. While the rules are complex, there are three basic beneficiary types that determine how quickly inherited IRA funds must be withdrawn (and taxed). 

• Eligible Designated Beneficiaries (EDBs) include your surviving spouse, your minor child (until they turn 21), a disabled or chronically ill individual, or someone less than 10 years younger than you. These individuals typically have the most flexibility as a Beneficiary - often stretching distributions over their lifetime, or until they turn 21, followed by a 10-year withdrawal period.  

• Non-Eligible Designated Beneficiaries include most other heirs like adult children and grandchildren. These beneficiaries generally must empty the inherited IRA within 10 years. If, prior to your death, you had already started taking required minimum distributions (RMDs), the Beneficiary must continue those withdrawals each year within the 10-year withdrawal period. 

• Non-Designated Beneficiaries, such as estates, charities, or improperly structured trusts often face a shorter withdrawal window - usually 5 years if you die before starting RMDs, or they must continue your existing RMD schedule if you had already begun. 
  

What should I do now if I own an IRA and want to make a smart beneficiary choice?

IRA beneficiary forms (importantly, not your Last Will and Testament) determine who inherits your IRA and can be changed at any time prior to death. If you haven’t reviewed those forms in a while, or if you’ve experienced a life event such as marriage, divorce, birth of a child/grandchild, etc., now can be a good time to do so with an eye toward who’s currently named as your Primary and Contingent Beneficiary.  

Your decision regarding IRA Beneficiaries should also be made in accordance with your overall estate plan.  Do your IRA Beneficiary choices line up with your overall estate distribution desires?  If you’re not sure, you’ll benefit from the guidance of a tax credentialed financial planner (like the team members at Sachetta). 

What should I do if I just inherited an IRA?

Inheriting an IRA brings newfound wealth, but also important tax considerations.  If you’ve recently become a beneficiary: 

• Please don’t rush to take money out. One conversation with a tax planner can help you avoid a costly mistake. 

• Confirm your status: spouse, child, trust, etc. 

• Identify whether annual RMDs are required and start mapping your timeline. 

• Use tools like Voya’s inherited IRA RMD calculator to run some initial numbers. 

How can I get guidance on IRA beneficiaries and estate planning?

Are you ready to revisit your beneficiary designations or trust language? Or have you recently inherited an IRA and aren’t sure what to do next? 

Schedule a conversation to learn more about becoming a Sachetta client. If we’re a good fit, we can talk about how our team supports clients navigating questions like these - with clear guidance and without judgment. 

Jeffrey Aron manages all aspects of Financial Planning and client services, including the preparation of comprehensive financial plans (retirement, education, cash flow, etc.), insurance and asset allocation recommendations, advanced estate planning strategies and of course, plan implementation. He specializes in servicing the unique planning needs of high-net-worth individuals and families, with a depth of experience covering all aspects of financial and estate planning.