• Marla Roeser

Inherited Retirement Accounts: Five Things You Need to Know

Almost everyone has some kind of retirement account—whether a 401(k), IRA, or pension—so proper estate planning for these funds is essential. From tax treatment to beneficiary designations, this article has the answers to your questions.


Will my beneficiaries owe taxes on the retirement accounts I pass down to them?

Probably. Assets like life insurance, real estate, vehicles, and nonretirement investment accounts are not counted as income when they are inherited. Retirement accounts, however, are “income in respect of a decedent,” and any amounts withdrawn from non-Roth accounts are subject to income tax at the beneficiary’s ordinary income tax rate.


Are all retirement accounts treated the same way?

No. Beneficiaries who inherit employer-sponsored plans, like 401(k)s and pensions, are often subject to more limitations and requirements than those who inherit IRAs. Often, the employer-sponsored plan will require account withdrawal within five years of the account owner’s death, even if the beneficiary does not need or want to withdraw money from the account. All withdrawals by the beneficiary are subject to income tax at the beneficiary’s ordinary income tax rate.


IRAs, by contrast, can sometimes be stretched out over the life expectancy of the beneficiary, allowing continued tax-deferred growth in the account and reducing the beneficiary’s immediate income tax liability. Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law on December 20, 2019, and effective for participants who die after 2019, this stretch treatment is available for Eligible Designated Beneficiaries (EDBs), which include the following types of beneficiaries:


surviving spouse of an account owner

person who is not more than ten years younger than the account owner

minor child of the account owner

disabled person

chronically ill person


Stretch treatment for IRAs left to individuals who are not EDBs, however, abruptly ends in the tenth year after the participant’s death when all of the IRA assets must be distributed to the beneficiary. (Note that many employer-sponsored plans require the balance to be distributed to an inherited IRA when the account owner dies, and those accounts must then be paid out in accordance with the stretch treatment that applies to that beneficiary.)


Who should I designate as my beneficiary?

Many people name their spouse as their primary beneficiary and then designate their children or other individuals as contingent beneficiaries. While this approach will usually avoid probate proceedings, it does not provide any level of preservation or protection for the inherited accounts and may not be consistent with the individual’s broader estate planning objectives.


Alternatively, it may make more sense to leave the retirement account to a carefully designed trust, which can provide ongoing benefits to spouses, children, and other beneficiaries. Holding the account in a trust can also provide protection against beneficiaries’ creditors. The identity of the trust’s beneficiary (EDB or non-EBD) will still determine the payout period for the retirement account. Regardless of whether a trust is established for a beneficiary that is an EDB, the trust’s level of creditor protection will depend on its status as a conduit or accumulation trust. Generally, an accumulation trust may offer greater creditor protection than a conduit trust: any distribution from the IRA that a conduit trust receives must be immediately distributed out to the beneficiary, whereas IRA distributions that an accumulation trust receives may build up inside the trust.


You should talk with a competent estate planning attorney to make sure you understand the income tax consequences of the two types of trusts. Although accumulation trusts offer greater creditor protection, retirement assets distributed to and held by an accumulation trust will usually be taxed at a much higher income tax rate than retirement assets passed out of the trust to a beneficiary.


Why should I use a trust? Is it risky?

In most cases, passing a retirement account to beneficiaries via a trust provides an increased level of protection and flexibility. The trust’s status as an accumulation or conduit trust will affect that level. A trust that is specifically designed to receive retirement account benefits allows the account to continue growing, on a tax-deferred basis, for as long as possible. It can also protect the inherited balance from the beneficiary’s creditors and allows for distribution in accordance with the deceased account holder’s wishes.


However, due to the income tax treatment of inherited retirement accounts, retirement trusts must be carefully drafted. If set up incorrectly, a trust could require the entire inherited account balance to be paid out within five years of the account owner’s death. In that case, any tax-deferred growth of the funds would be lost, and beneficiaries would be faced with a substantial income tax bill earlier than expected. Additionally, the funds would be subject to the claims of any of the beneficiaries’ bankruptcy or judgment creditors.


How do I get started?

Your estate planning attorney can review your retirement plan’s documentation and work with you to make sure the account is distributed in a way that is consistent with your overall estate planning objectives. A good attorney can also help ensure that beneficiary designation forms are written correctly and, if needed, help you set up a retirement trust properly.

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