How to Handle an Inheritance Without Blowing It

Receiving an inheritance is bittersweet. Someone you loved has died, and their money has come to you. The emotional weight makes rational decision-making harder, not easier. And the decisions are significant.

If you inherited an IRA, the rules are complex. Under the SECURE Act, most non-spouse beneficiaries must empty the entire inherited IRA by December 31 of the 10th year following the year of the original owner's death. Final IRS regulations effective January 1, 2025 confirm that if the original owner had reached their required beginning date for RMDs, annual RMDs are required during years 1 through 9 of the 10-year period. Failing to take RMDs triggers a 25% penalty on the missed amount.

Studies show that approximately 70% of families lose their inherited wealth by the second generation. The causes are predictable: lifestyle inflation, impulsive purchases, lack of tax planning, and failure to understand the inherited IRA rules. If you are searching for how to handle an inheritance without blowing it, this guide covers the tax rules, the IRA distribution options, the deployment strategy, and the psychological traps.

Inherited IRA Rules: The 10-Year Rule

The SECURE Act framework

For deaths after 2019, most non-spouse beneficiaries must empty the inherited IRA by December 31 of the 10th year following the year of death. If the owner died in 2025, the beneficiary must empty the account by December 31, 2035. This is a hard deadline with no extensions.

According to the IRS Retirement Topics: Beneficiary page, the 10-year rule replaced the old "stretch IRA" strategy that allowed beneficiaries to take distributions over their own life expectancy. Most non-spouse beneficiaries lost that option.

Annual RMDs within the 10-year window

The final IRS regulations issued in July 2024 and effective for calendar years beginning on or after January 1, 2025 settled a question that had been debated for years. If the original owner had reached their required beginning date (RBD), annual RMDs are required during years 1 through 9 of the 10-year period. If the original owner had NOT reached their RBD, no annual RMDs are required. You just empty the account by year 10.

The RBD is April 1 of the year after the owner turns 73 (for those born 1951 through 1959) or 75 (for those born 1960 or later). The IRS waived penalties for missed annual RMDs during 2021 through 2024, but that waiver ended. Annual RMDs are required starting in 2025, and the 25% penalty now applies to missed amounts.

The 25% penalty

Missing an RMD triggers a 25% excise tax on the missed amount. SECURE 2.0 reduced the penalty to 10% if you correct the missed RMD within two years. A $20,000 missed RMD costs $5,000 in penalties, or $2,000 if corrected within the two-year window. The penalty is reported on Form 5329.

Eligible Designated Beneficiaries

Who is exempt from the 10-year rule

Certain beneficiaries are classified as eligible designated beneficiaries and can use the old life-expectancy stretch method instead of the 10-year rule:

• Surviving spouse: can roll into their own IRA, delay RMDs until their own RBD, or treat as inherited
• Minor child of the account owner: the 10-year rule starts when they reach the age of majority (18 or 21, depending on state)
• Disabled or chronically ill individual: can take distributions over their own life expectancy
• Individual not more than 10 years younger than the account owner: life expectancy distributions
• Certain trusts for the above categories

Spousal options (the most flexible)

A surviving spouse has three options. Option 1: roll the inherited IRA into their own IRA. This is the simplest path and delays RMDs until the spouse's own RBD. Option 2: treat it as an inherited IRA. This allows distributions without the 10% early withdrawal penalty, even before age 59.5. Option 3: disclaim the inheritance, which passes it to the contingent beneficiary.

Vanguard's inherited IRA guide walks through the spousal options in more detail. The right choice depends on the surviving spouse's age, income, and whether they need the money now or want to delay taxes.

Roth IRA Inheritance

The 10-year rule still applies to non-spouse beneficiaries of Roth IRAs. The key difference: no annual RMDs are required during the 10-year period because Roth IRAs are not subject to RMDs during the owner's lifetime. Distributions are tax-free if the original owner's Roth IRA met the 5-year holding rule (opened at least 5 years before the death). If the 5-year rule was not met, earnings may be taxable, though contributions come out tax-free.

A surviving spouse can roll an inherited Roth IRA into their own Roth IRA. This is the best-case scenario for beneficiaries. Ten years of tax-free growth with no RMD requirements.

Tax Considerations

Federal estate tax

The 2026 federal estate tax exemption is $15 million per individual and $30 million per married couple. The One Big Beautiful Bill Act made this higher exemption permanent with no sunset date, replacing the prior $13.99 million per person exemption that was scheduled to revert to about $5 million at the end of 2025. Most inheritances are well below this threshold and face no federal estate tax.

Income tax on inherited IRAs

Traditional IRA and 401(k) distributions are taxed as ordinary income at your marginal rate. Roth IRA distributions are tax-free if the 5-year rule is met. Non-retirement assets (cash, brokerage accounts, real estate) carry no income tax on the inheritance itself. You inherit at the stepped-up basis, which is the fair market value at the date of death.

State inheritance tax

Five states still levy an inheritance tax in 2026: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Iowa fully repealed its inheritance tax effective January 1, 2025. Tax rates and exemptions vary by state and by your relationship to the deceased. Spouses are exempt in every state. Direct descendants are exempt or near-exempt in most. Unrelated heirs pay the highest rates, up to 15 or 16 percent. Check your state's rules before spending the inheritance.

The Deployment Strategy

Step 1: Pause (30 to 60 days)

Park the cash in a high-yield savings account. Do not make major decisions while grieving. Do not tell extended family or friends about the inheritance. Grief and money make poor companions, and the urge to "do something" is strong. The best first move is to wait.

Step 2: Understand the rules

If you inherited a retirement account, determine three things: was it traditional or Roth? Had the owner reached their required beginning date? Are you an eligible designated beneficiary? Consult a CPA or tax professional to understand your RMD requirements and tax implications before taking any distributions.

Step 3: Deploy in order

1. Pay off high-interest debt (credit cards, personal loans). This is a guaranteed return equal to the interest rate.
2. Build or top up your emergency fund to 6 months of expenses.
3. Max out tax-advantaged accounts (401(k), IRA, HSA) for the year.
4. Invest the remainder in a diversified portfolio. Our guide on what is a taxable brokerage account covers the basics.
5. Consider charitable giving if it aligns with your values. See our guide on how to give to charity without hurting your financial goals.
6. Set aside 5 to 10 percent for something meaningful: a trip, a memorial, a donation to a cause the person cared about. This honors their legacy.

If you inherited an IRA and need the income, take distributions as required and use them. If you do not need the income, minimize distributions to only the required RMDs and let the rest grow tax-deferred until year 10. If you are in a lower tax bracket than the original owner was, taking distributions may be tax-efficient. Consult a tax professional before taking large distributions. For automating the deployment, read our guide on how to set up automatic investing.

Inherited IRA Beneficiary Options

Three Real Inheritance Scenarios

Example 1: Sarah, 45, inherits a $300,000 traditional IRA from her father

Sarah's father died in 2025 at age 76, past his required beginning date. She is a non-spouse, non-eligible designated beneficiary. The 10-year rule applies, so she must empty the account by December 31, 2035. Annual RMDs are required in years 1 through 9 because her father had reached his RBD.

If Sarah ignores the RMDs and takes nothing for 9 years, then withdraws $300,000 in year 10, she misses 9 years of RMDs. If her year 1 RMD is $10,000, the penalty is $2,500 per missed year. Over 9 years, penalties could exceed $25,000.

Her strategy: take annual RMDs calculated using the Single Life Expectancy Table, invest them in a brokerage account, and let the inherited IRA continue growing tax-deferred. In year 10, she withdraws the remaining balance. This minimizes penalties, spreads the tax burden across multiple years, and maximizes growth.

The 10-year rule does not mean "wait 10 years and take it all." If the owner reached RBD, annual RMDs are required. Ignoring them is expensive.

Example 2: Michael, 55, inherits a $150,000 Roth IRA from his mother

Michael's mother died in 2025 at age 70. She opened the Roth IRA in 2015, so the 5-year rule was met. He is a non-spouse beneficiary. The 10-year rule applies, meaning he must empty the account by December 31, 2035. No annual RMDs are required because Roth IRAs are not subject to RMDs. All distributions are tax-free.

His strategy: leave the money in the Roth IRA for 10 years and let it grow tax-free. In year 10, take the entire balance. If the $150,000 grows at 7% annually for 10 years, it becomes approximately $295,000. All of it tax-free.

Inherited Roth IRAs are the best-case scenario. No RMDs, no taxes, 10 years of tax-free growth. Do not touch it until year 10.

Example 3: Robert, 60, inherits $500,000 in cash and a $200,000 brokerage account

Robert's aunt left him non-retirement assets. The brokerage account receives a stepped-up basis to fair market value at the date of death. His aunt bought the stocks for $100,000, but they were worth $200,000 when she died. The basis steps up to $200,000. If Robert sells immediately, he pays $0 in capital gains tax.

His strategy: pause for 60 days. Then deploy. Pay off $30,000 in credit card debt (a guaranteed 22% return). Top up his emergency fund to 6 months ($30,000). Max out his 401(k) and Roth IRA for the year. Invest the remaining $350,000 in a diversified portfolio. Set aside $25,000 (5%) for a memorial trip to honor his aunt.

Non-retirement inheritances are simpler because no RMD rules apply, but they still require discipline. The stepped-up basis is a significant tax advantage. Use it. For more windfall management strategies, read our guide on what to do if you receive a large lawsuit settlement.

Common Mistakes That Destroy Inheritances

Missing RMDs on inherited IRAs is the most expensive mistake. The 25% penalty on missed RMDs is brutal. If the original owner had reached their required beginning date, annual RMDs are required during the 10-year period. Take them.

Taking everything at once creates a massive tax bill. Emptying an inherited traditional IRA in a single year can push you into the highest tax bracket. Spread distributions over multiple years to stay in a lower bracket.

Assuming inherited Roth IRAs have RMDs is a common misconception. They do not. Non-spouse beneficiaries have 10 years but no annual RMDs. Let it grow tax-free.

Not using the stepped-up basis wastes a major tax advantage. Non-retirement assets get a stepped-up basis at death. Selling immediately means $0 capital gains on appreciation that occurred during the deceased's lifetime.

Making major decisions while grieving leads to regret. Pause for 30 to 60 days. Do not buy a house, quit a job, or make large purchases during the grief period.

Telling people about the inheritance invites requests for loans, gifts, and "investment opportunities." Keep it private. The fewer people who know, the fewer hands will be out.

Not consulting a tax professional is false economy. Inherited IRA rules are complex. A CPA can help you optimize distribution timing, avoid penalties, and minimize taxes. The cost of a consultation is a fraction of what a single mistake can cost.

Spending the principal on lifestyle treats an inheritance as a bonus rather than capital. Deploy it to build long-term security, not to inflate your lifestyle. For a values-based approach, read our guide on how to set financial goals that align with what you actually care about.

Deploy the Inheritance Wisely

Handling an inheritance requires understanding the rules and managing your emotions. Most non-spouse beneficiaries must empty inherited IRAs by December 31 of the 10th year following the year of death. If the original owner had reached their required beginning date, annual RMDs are required during years 1 through 9. Missing them triggers a 25% penalty. Eligible designated beneficiaries have different options, and spouses can roll into their own IRA. Roth IRA inheritances have no annual RMDs and grow tax-free for 10 years. Non-retirement assets receive a stepped-up basis at death.

The 2026 federal estate tax exemption is $15 million per individual. Five states still levy an inheritance tax. The deployment strategy is straightforward: pause 30 to 60 days, understand the rules, then deploy in order (debt, emergency fund, tax-advantaged accounts, invest, charitable giving, memorial).

Do three things in your first 60 days. If you inherited a retirement account, determine whether the original owner had reached their required beginning date. This determines whether you need annual RMDs. Consult a CPA. Park the inheritance in a high-yield savings account and do not invest or spend for 60 days. Let the emotions settle. Write down the deployment order: debt, emergency fund, tax-advantaged accounts, invest, memorial. Then execute it.

The person who left you this inheritance spent a lifetime building it. Honor that by using it wisely.

This post is for informational purposes only and does not constitute financial, tax, or legal advice. Inherited IRA rules are complex and subject to change. Consult a qualified CPA or tax professional before making distribution decisions. State inheritance tax laws vary and change over time.