Inheriting a retirement account used to be a straightforward financial blessing. Today, it is an intricate legal responsibility that, if mishandled, can turn a legacy into a tax liability.
The days of the simple “stretch IRA,” where almost any beneficiary could extend distributions over their lifetime, are largely over for non-spouses.
For families in Central and Southeastern Kentucky, this shift requires a move from passive acceptance to active legal planning. You are handling a decision tree with significant tax consequences.
The difference between a well-executed plan and a default payout can be the difference between preserving family wealth or losing over a third of it to federal taxes and the new 25% excise tax penalty.
At Elder Law Guidance, we help you handle these waters with confidence.
Understanding the SECURE Act 2.0 and the 10-Year Rule
The legality of inherited retirement accounts is now defined by the SECURE Act and the subsequent IRS final regulations. The headline change is the “10-Year Rule.”
For most non-spousal beneficiaries (like adult children), the entire account balance must be distributed by the end of the 10th year following the account owner’s death. However, the confusion lies in how that money must come out during those ten years.
Under the 2026 enforcement rules, if the original account owner had already begun taking Required Minimum Distributions (RMDs), the beneficiary cannot simply wait until year 10 to cash out. You must continue taking annual distributions for years one through nine, and empty the account by year ten.
Failure to comply results in a penalty that is severe even by IRS standards, an excise tax of 25% on the amount that should have been withdrawn.
3 Types of Beneficiary Status
Effective legal planning starts with identity. The IRS now segments heirs into strict categories. Your legal strategy depends entirely on which class of beneficiary you fall into.
1. Eligible Designated Beneficiaries (EDBs)
This group retains the privilege of “stretching” distributions over their life expectancy, minimizing the annual tax bite. This category includes:
- Surviving Spouses: They have the most flexibility, including the ability to treat the account as their own.
- Minor Children of the Decedent: Note that this status expires. Once the child reaches the age of majority (21, per federal tax regulations), they switch to the 10-year rule.
- Disabled or Chronically Ill Individuals: Strict legal definitions apply here to qualify for EDB status.
- Individuals Not More Than 10 Years Younger: Typically siblings or partners.
2. Non-Eligible Designated Beneficiaries (Non-EDBs)
This group includes most adult children and grandchildren. If you fall here, you are subject to the 10-Year Rule. The planning challenge is not if the money comes out, but when, to avoid spiking your income tax bracket.
3. Non-Designated Beneficiaries
This occurs when an estate, charity, or a trust that fails “see-through” requirements is named. This often forces a rapid 5-year payout, accelerating tax liability.
Strategies for Spouses
For a husband or wife, the legal pathways are robust. However, choosing the default option isn’t always the best move. Understanding surviving spouse rights in Kentucky is critical when integrating retirement accounts into a broader estate plan.
- Spousal Rollover: You move the funds into your own IRA. The RMDs pause until you reach RMD age (currently 73). This is usually the superior choice for younger spouses.
- Inherited IRA: You keep the account in the deceased spouse’s name. If you are under 59½, this allows you to access funds without the 10% early withdrawal penalty, a vital liquidity tool for younger widows or widowers.
- The SECURE 2.0 Election: A surviving spouse can elect to be treated as the deceased employee for RMD purposes, potentially delaying distributions further if the deceased was younger.
However, none of these strategies take into account the need to plan for long term car needs. Additional tax planning strategies may involve gradually increasing liquidity in retirement and sheltering assets in a trust to avoid RMD “bleeds” if long-term care is needed.
Asset Protection vs. The Tax Trap
Many of our clients in Richmond and Lexington want to leave retirement assets to a Trust rather than directly to a child. This is a sound legal strategy for asset protection, making sure the inheritance isn’t lost to a beneficiary’s divorce, creditors, or lawsuits.
However, trusts and IRAs have a volatile relationship. If your Trust is not drafted with specific “See-Through” provisions, the IRS may force a 5-year payout. Even worse is the “Trust Tax Trap.”
Conduit vs. Accumulation Trusts
- Conduit Trusts: The Trustee must pass the RMD out to the beneficiary immediately. The beneficiary pays the income tax at their personal rate. This protects the principal but not the income.
- Additional trust tax strategies may allow mitigation of income as taxable.
- Accumulation Trusts: The Trustee can hold the money inside the Trust for greater protection. Here is the danger: Trusts hit the maximum federal income tax bracket (37%) at roughly $15,000 of income (2025 figures).
Compare this to an individual, who doesn’t hit that 37% rate until over $600,000 of income (for married couples). If you are planning strategies for managing inherited IRA assets, you must weigh the cost of high taxes against the value of strict asset protection.
Managing the Tax Impact
Once we have established the legal vehicle (Individual or Trust) and the timeline (Life Expectancy or 10 Years), we look at optimization. The goal is to smooth out the income to make sure you don’t jump into a higher tax bracket unnecessarily.
The Bracket Leveling Strategy
Instead of taking minimal distributions and getting hit with a massive balloon payment in Year 10 (which could push you into the highest tax bracket), we model a distribution curve. It may make sense to withdraw more than the minimum in years where your other income is low (e.g., prior to claiming Social Security or in a year between jobs).
Roth Conversions and Disclaimers
For some heirs, a “Qualified Disclaimer” allows them to refuse the inheritance legally, passing it to the next beneficiary in line (often their own children) without tax consequences. This is a high-level play useful when the primary beneficiary is already wealthy and wishes to pass assets to a younger generation with a lower tax rate.
Furthermore, analyzing what planning strategies help manage inherited IRA assets usually leads us to look at Roth accounts. Inherited Roth IRAs still face the 10-year rule, but the distributions are generally tax-free, allowing the funds to grow untouched for the full decade before a tax-free withdrawal in Year 10.
Avoiding the 25% Penalty
The IRS has signaled that 2025 is the year of enforcement. If you missed RMDs in previous years due to the confusion over the 10-year rule, the IRS has largely waived penalties for 2021-2024. However, that grace period is ending.
The penalty for a missed RMD is 25%. If you correct the error within two years, this can be reduced to 10%. But why pay a penalty at all?
When we assist clients with how to fund a trust or administer an estate, we make sure that the beneficiary designations align with the actual RMD requirements. A mismatched beneficiary form is the single most common cause of unnecessary tax acceleration.
Next Steps for Kentucky Families
The laws regarding inherited wealth are not designed to be intuitive, they are designed to be strict. At Elder Law Guidance, we believe that you should control your legacy, not the IRS.
If you live in Kentucky, the first step is a review of your beneficiary designations and your Trust language.
Don’t guess at the new 2025 regulations. Let us help you build a plan that protects your assets and your family’s future.
