Inherited an IRA or 401(k)? Check the clock before you touch it

Quick answer: Don't cash anything out and don't roll it into your own IRA. Find out which kind of beneficiary you are, move the money by direct transfer into an inherited account, and plan the withdrawals so they don't land in one tax year. Rules and dates change, so confirm everything at IRS.gov.

A check for $300,000 made out to you sounds like good news. For a traditional IRA, it's a tax bill with your name on it. The money was never taxed on the way in. Every dollar you take out counts as ordinary income in the year you take it.

That's why the first week matters more than the first year.

Find out which kind of beneficiary you are

Since the SECURE Act of 2019, the rules depend on who you are to the person who died.

Eligible designated beneficiaries get the most room. That's a surviving spouse, a minor child of the owner, a disabled or chronically ill person, or someone no more than ten years younger than the owner. Most of them can stretch withdrawals over their own life expectancy.

Everyone else who's a person, which means most adult children, grandchildren, nieces and nephews, falls under the ten-year rule. The account has to be empty by December 31 of the tenth year after the owner's death.

Estates, charities and some trusts follow different, tighter timelines. If a trust is named, get the trust's attorney involved early.

One wrinkle on the minor child: the ten-year clock starts when they reach the age of majority, not at the death.

The wrinkle that caught people off guard

Ten years doesn't always mean ten years of doing nothing.

If the owner had already started required minimum distributions (RMDs) when they died, the IRS final regulations in 2024 say most ten-year beneficiaries must also take an annual withdrawal in years one through nine, then empty the rest by year ten. If the owner died before reaching that stage, you can generally wait and take it all at the end, as long as you make the deadline.

The IRS gave relief for missed annual withdrawals in 2021 through 2024. That relief doesn't last forever. Check the current rule on IRS.gov or have a CPA confirm which one applies to you.

Also watch for this: if the owner died partway through the year and hadn't taken that year's RMD, the beneficiary has to take it by December 31. People miss this one because the grief is fresh and the paperwork is slow.

Move the money the right way

If you're not the spouse, you can't roll an inherited IRA into your own. Do that and the IRS treats it as a full withdrawal. The whole balance becomes taxable income, and no one can reverse it.

The correct move is a direct, trustee-to-trustee transfer into an inherited IRA, titled something like "Robert Smith (deceased) IRA, for the benefit of Mary Smith, beneficiary." Inherited 401(k) money can usually move the same way. Ask the custodian to send it directly to the new account. Never accept a check payable to you.

Good news on one front. The usual 10% early-withdrawal penalty doesn't apply to inherited accounts, whatever your age. You'll pay income tax, but not a penalty for being under 59½.

If you're the surviving spouse

You have more choices than anyone else, and the right one depends on ages.

• Treat it as your own. Simple, and it lets you delay RMDs until your own required age. But withdrawals before 59½ may carry the 10% penalty.
• Stay a beneficiary. If you're younger than 59½ and need to draw on the money, this keeps the penalty away.
• Take a lump sum. Rarely wise. It's taxable all at once.

Don't decide in the first month if you don't have to. A spouse has time, and a fee-only adviser can run both paths with your real numbers.

Spread it out, or you'll pay for the delay

Take this as an illustrative example only, not a prediction. Say a 50-year-old inherits a $300,000 traditional IRA from a parent who died before RMDs began. Ignore investment growth to keep the math clean.

• Wait until year ten: $300,000 lands on top of your salary in a single tax year. It can push you into a much higher bracket, and it can raise the cost of other things tied to income.
• Spread it evenly: $30,000 a year over ten years. Each slice stacks on top of your paycheck, but the bracket jump is far smaller.

In real life the account keeps growing while you wait, so the lump in year ten is bigger than $300,000. Waiting isn't free.

There's a counter-case. If you expect a low-income year, such as a layoff, a sabbatical or the early years of your own retirement, it can make sense to take more that year and less in others. A CPA can model it. A fee-only adviser can tell you whether the investments inside the account should change while you hold it.

Inherited Roth accounts are different

A Roth IRA left to you generally still follows the ten-year rule. But the owner never had RMDs, so you usually don't owe yearly withdrawals in the meantime. And qualified withdrawals are generally tax-free if the Roth was open long enough.

That makes the timing question easier. The longer money stays inside, the longer it grows untaxed, so many people leave a Roth until year ten. Confirm the five-year holding rule with the custodian before you count on it.

What a mistake costs

Miss a required withdrawal and the excise tax is 25% of what you should have taken. If you fix it within a couple of years, it can drop to 10%. Those are the current numbers. They've changed before, so verify them at IRS.gov.

The custodian will not chase you. They'll send forms, but the deadline is yours.

A short list for week one

• Get several certified copies of the death certificate.
• Find the beneficiary designation form. It, not the will, controls who gets the money. (Your Will Doesn't Control Most of Your Money explains why.)
• Call the custodian and ask which beneficiary category they have you in.
• Ask whether the owner took the current year's RMD.
• Set up the inherited IRA by direct transfer.
• Book an hour with a CPA before the first withdrawal, not after.

If you're also deciding which of your own accounts to spend from, Which Retirement Account To Spend From First covers how inherited money fits in your overall order.

This is general education, not individual tax, legal or financial advice. Your facts decide the answer. A fee-only fiduciary adviser, a CPA or an estate attorney should check yours before you act.

Do the person after you a favor

Whoever inherits from you will be sorting this out at the worst time of their life. Make it a five-minute job for them. Pull out your beneficiary forms this weekend. Check that the names are right, that there's a backup name, and that the form says what you think it says. Then tell your kids where the paperwork lives.

Leave it better than you found it.