The Hidden Tax Cost of Inherited IRAs: What Virginia Business Owners Need to Know About the SECURE Act

If you have a meaningful balance in a traditional IRA or 401(k), you have probably given some thought to how that account fits into your retirement income. What often gets less attention is what happens to that account after you are gone, and how much of it your heirs actually get to keep after taxes.

The SECURE Act changed the rules for inherited retirement accounts in a way that many families have not fully absorbed. For business owners in particular, whose heirs may already have significant income from the business, the timing of these rules can create a tax problem that is easy to miss until it is too late to plan around.

Key takeaways

Most non-spouse beneficiaries who inherit an IRA must now empty the account within 10 years, not stretch it over their lifetime.
Traditional IRA withdrawals are generally taxed as ordinary income, which can push heirs into a higher tax bracket in the years they take distributions.
Some beneficiaries also owe annual required distributions during years one through nine, depending on when the original owner died relative to their required beginning date.
Missing a required distribution can trigger an IRS excise tax.
Business owners should coordinate IRA beneficiary planning with succession and estate plans, since a large IRA distribution can land in the same year as business income.

What the SECURE Act actually changed

Before the SECURE Act, many non-spouse beneficiaries could stretch distributions from an inherited IRA over their own life expectancy, often decades. That approach let the account continue growing tax-deferred while spreading out the tax bill.

Under current rules, the IRS explains that most non-spouse beneficiaries of an inherited IRA must generally empty the account by the end of the 10th calendar year after the original owner's death. There is no requirement to take anything out in years one through nine in every case, but there are important exceptions.

Who is exempt from the 10-year rule

The IRS and congressional research summaries identify a category called eligible designated beneficiaries who are not subject to the 10-year rule in the same way. This generally includes:

A surviving spouse
A minor child of the original owner, until they reach the age of majority
A beneficiary who is disabled or chronically ill
A beneficiary who is not more than 10 years younger than the original owner

Everyone else, including most adult children, is generally treated as a non-eligible designated beneficiary and falls under the 10-year rule.

The part that surprises people: annual distributions may still be required

Here is where the hidden cost comes in. If the original account owner had already reached their required beginning date for RMDs before they passed away, the IRS final regulations generally require the beneficiary to take annual life-expectancy-based required distributions during years one through nine of the 10-year window, and then fully empty the account by the end of year 10.

If the original owner died before their required beginning date, the beneficiary generally does not have annual RMDs during years one through nine, but the account still needs to be fully depleted by the end of year 10.

Either way, the account cannot simply sit and grow tax-deferred for a decade the way it once could.

Why this creates a hidden tax cost

The 10-year rule itself is not necessarily the problem. The tax cost comes from how and when distributions get taken, and how they interact with an heir's other income.

Withdrawals from a traditional inherited IRA are generally taxable as ordinary income in the year they are taken. That means a large distribution can stack directly on top of an heir's salary, business profits, or other income, potentially pushing them into a higher tax bracket for that year.

This is especially relevant for business owners' families. If an adult child who works in or owns part of the family business inherits a sizable IRA, a required distribution in a high-income year for the business could mean a larger combined tax bill than the family expected.

A common misconception is that beneficiaries can simply wait until year 10 and take one lump distribution with no consequence before then. In reality, tax may still be due earlier depending on the required distribution schedule, and waiting until the final year to withdraw everything at once often creates the largest possible tax spike in a single year.

Another misconception worth correcting: not all inherited retirement accounts are taxed the same way. A Roth IRA that has met the 5-year rule can generally be withdrawn tax-free by a beneficiary, while a Roth that has not met that threshold may have taxable earnings. Traditional and Roth inherited accounts should be evaluated separately.

Finally, missing a required distribution is not a minor paperwork issue. Sources describe a potential excise tax framework for missed required amounts, so beneficiaries and their advisors need to track deadlines carefully rather than assume there is no downside to a delay.

Planning strategies worth discussing with an advisor

None of these are one-size-fits-all solutions, and none of them are tax or legal advice. They are starting points for a conversation with us and with your tax or estate professional about your specific situation.

Roth conversions during your lifetime

Converting a portion of a traditional IRA to a Roth IRA while you are alive means you pay the tax at conversion, potentially at a rate you can plan for and manage. Your heirs may then inherit a Roth account that can be withdrawn tax-free once the 5-year rule is satisfied, rather than a traditional account that generates ordinary income for them during the 10-year window.

Trust versus individual beneficiary designations

How an IRA is titled and who is named as beneficiary matters a great deal. In some situations a trust named as beneficiary can help control the timing and use of distributions, particularly when a beneficiary is a minor, has special needs, or when a family wants more structure around how the money is used. Trust-owned inherited IRAs have their own set of rules and should be reviewed with an estate planning professional.

Life insurance to help offset the tax hit

Some families use life insurance as a way to help replace value that will be lost to taxes on a large inherited IRA, or to provide liquidity so heirs are not forced to take a distribution at an inopportune time just to cover a tax bill.

Charitable giving strategies

For IRA owners who are charitably inclined, a qualified charitable distribution during your lifetime, or naming a charity as a beneficiary of part of the IRA, can be a way to direct funds toward causes you care about while potentially reducing what heirs face in ordinary income tax on the same account.

Coordinating IRA planning with business succession

For business owners, it is worth reviewing how retirement account distributions to a family member could land in the same tax year as income from the business, a buyout, or a succession event. Spreading out major financial events, where possible, can help avoid stacking multiple large income items into a single tax year for the same person.

Common mistakes to avoid

Assuming an inherited IRA is automatically tax-free. Traditional IRA distributions are generally taxable as ordinary income.
Waiting until year 10 to take a single lump distribution, which can create the largest possible tax spike.
Overlooking whether annual distributions are required during years one through nine based on the original owner's age and RMD status.
Naming beneficiaries once and never revisiting the choice as tax law, family circumstances, or business ownership change.
Treating business succession planning and retirement account beneficiary planning as two separate, unrelated projects.

When to talk with us

If you have a meaningful IRA or 401(k) balance and have not reviewed your beneficiary designations since the SECURE Act rules took effect, now is a reasonable time to take a look. This is especially true if you are a business owner thinking about succession, or if your heirs are already in a high income bracket.

We do not provide tax or legal advice directly, and we always recommend working alongside your tax and estate planning professionals. What we can do is help you look at your overall retirement, estate, and business succession picture together, so your beneficiary designations and tax strategy are coordinated rather than left to chance.

If you would like to review your inherited IRA exposure and beneficiary designations as part of a broader financial plan, schedule a complimentary conversation with us.

Frequently asked questions

Does the 10-year rule apply to every inherited IRA? No. Eligible designated beneficiaries, including a surviving spouse, a minor child of the account owner, a disabled or chronically ill individual, and someone not more than 10 years younger than the original owner, are treated differently than the general 10-year rule.

Do I have to take money out every year during the 10-year window? It depends. If the original owner had already reached their required beginning date for RMDs before death, annual distributions are generally required during years one through nine, with the account fully emptied by year 10. If the owner died before that date, annual distributions may not be required, but the account still must be emptied by the end of year 10.

Is money from an inherited IRA taxed? Traditional IRA distributions are generally taxed as ordinary income to the beneficiary. Roth IRA distributions may be tax-free if the Roth has satisfied the 5-year rule; otherwise earnings may be taxable.

What happens if I miss a required distribution? Missed required distributions can trigger an IRS excise tax. Correction procedures exist, but the details depend on your specific situation, so this is worth reviewing promptly with a tax professional.

Why does this matter more for business owners? A large inherited IRA distribution is taxed as ordinary income in the year it is taken. If an heir also has significant business income in that same year, the combined income could push them into a higher tax bracket than either amount alone would.

Can a trust be named as the IRA beneficiary instead of a person? Yes, in some cases. Trust-owned inherited IRAs have their own rules and can offer more control over distributions, but they should be set up carefully with an estate planning professional.

Does converting to a Roth IRA avoid the 10-year rule? No, inherited Roth IRAs are also generally subject to the 10-year distribution rule for non-eligible designated beneficiaries. The benefit of a Roth conversion during your lifetime is that qualified withdrawals by your heirs may be tax-free, not that the 10-year emptying requirement disappears.

Is there a Virginia-specific rule for inherited IRAs? Inherited IRA distribution rules are governed by federal law and IRS guidance, not a separate Virginia process. Virginia residents should still be aware of how a large distribution affects their overall federal and state income tax picture.

What should I do first if I recently inherited an IRA? Confirm whether the original owner died before or after their required beginning date for RMDs, determine whether you qualify as an eligible designated beneficiary, and identify whether the account is traditional or Roth. From there, a tax professional or advisor can help map out a distribution schedule.

Should I wait to review my own beneficiary designations? Reviewing beneficiary designations periodically, especially after a major life or business event, helps ensure your retirement accounts pass to heirs in a way that reflects both your wishes and current tax rules.

Sources

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