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Does Your Inherited IRA Need an Indirect Stretch?

Does Your Inherited IRA Need an Indirect Stretch?

If you have recently inherited an IRA, you might find yourself navigating a maze of tax forms and regulatory deadlines. It is a common feeling. The rules governing inherited retirement assets have shifted significantly in recent years, leaving many beneficiaries unsure of their next steps.

The SECURE Act of 2019 eliminated the traditional “stretch IRA” for most non-spouse beneficiaries; a strict 10-year timeline replaced lifetime distributions. Despite this change, there are still strategic ways to optimize this windfall.

Understanding the "10-Year Rule" and Current IRS Requirements

For designated beneficiaries (such as adult children inheriting from a parent) who inherited an IRA from an owner who passed away after December 31, 2019, the assets must generally be fully distributed by December 31 of the tenth year following the year of death.

However, your annual requirements during that 10-year window depend heavily on whether your parent had already reached their Required Beginning Date (RBD) for taking Required Minimum Distributions (RMDs):

  • If the deceased passed away BEFORE reaching their RMD age: You are not required to take annual distributions during years 1 through 9. You have the flexibility to withdraw the funds as you see fit, provided the account is empty by the end of the 10th year.
  • If the deceased passed away AFTER reaching their RMD age: Under finalized IRS regulations, you cannot simply wait until Year 10. You must take annual RMDs the first nine years, and then fully empty the account in the 10th year.

An Example Strategy: Recreating the "Stretch" Through Your Workplace 401(k)

When you are forced to empty an inherited traditional IRA within a decade, those distributions are taxed as ordinary income. If you take large lump sums, you risk entering a higher tax bracket.

If you feel behind on your own retirement plans, a highly effective “indirect stretch” strategy can help offset this tax impact while fueling your own long-term wealth. 

While you cannot directly roll an inherited IRA into your own active workplace 401(k), you can coordinate the cash flows:

  1. Max out your workplace plan. Increase your elective salary deferrals to your workplace 401(k) up to the maximum annual limit.
  2. Supplement your net income. Because your paychecks will be smaller due to the increased 401(k) contributions, you can take systematic, targeted distributions from the inherited IRA to replace that “lost” take-home pay.
  3. View the result. You have effectively transferred taxable assets out of the inherited IRA (where they had a mandatory 10-year expiration date) and shifted them into your own retirement plans. There, they can continue to compound tax-deferred based on your lifespan, effectively reviving the long-term “stretch” concept.

Considerations Before Adopting an Inherited IRA Strategy

Take time to review it with a qualified professional. Some factors can have a significant impact on whether it’s the right fit for your situation:

  • Cash Flow: Make sure you can comfortably manage your monthly living expenses while increasing retirement plan contributions and taking distributions from your inherited IRA.
  • Tax Bracket: Review your current marginal tax rate to determine whether the tax savings from deductible retirement contributions will offset the taxable income from your inherited IRA distributions.
  • State Taxes: Don’t overlook state income taxes that may affect the overall tax benefit of this strategy.

Every person’s financial situation is different. Before moving forward, make sure to partner with a trusted wealth management professional to evaluate your complete financial picture and determine whether this approach aligns with your long-term goals.

Frequently Asked Questions About an Inherited IRA

If you fail to withdraw a required minimum distribution from an inherited IRA by the December 31 deadline, the IRS can impose an excise tax. This penalty is 25% of the amount that should have been withdrawn.

Yes. While original owners of Roth IRAs do not have to take RMDs during their lifetime, beneficiaries who inherit them are still subject to the 10-year rule. The good news is that qualified distributions from an inherited Roth IRA are typically tax-free. Additionally, you generally do not have to take annual RMDs in years 1 through 9 for an inherited Roth IRA, even if the original owner died after their RMD age.

Certain individuals are exempt from the strict 10-year liquidation rule and can still “stretch” distributions over their lifetime. The IRS defines Eligible Designated Beneficiaries as:

  • The surviving spouse
  • Minor children of the account owner (until they reach the age of majority, at which point the 10-year clock starts)
  • A disabled or chronically ill individual
  • Individuals who are not more than 10 years younger than the deceased account owner