You may spend decades building wealth, saving for retirement, and investing with the goal of leaving something meaningful to your children. But what happens when that money finally passes to the next generation?

For many families, a significant portion of their wealth is held in traditional IRAs, 401(k)s, and other tax-deferred retirement accounts. These accounts offer valuable tax benefits during your lifetime, but they can create a very different financial picture for the people who inherit them.

Thanks to changes under the SECURE Act, many non-spouse beneficiaries now have a limited window to withdraw inherited retirement assets. Depending on the size of the account, their existing income, and the timing of those withdrawals, the resulting tax bill could take a substantial bite out of their inheritance.

The uncomfortable truth? Inheriting $1 million doesn't necessarily mean keeping $1 million.

Understanding the rules before you inherit, or before you pass wealth to your family, can help you make more informed decisions about your financial future.

The stretch IRA is gone. Here's what that means for your family.

For years, many beneficiaries could use a strategy known as the “stretch IRA.” This allowed eligible non-spouse beneficiaries to spread required withdrawals from an inherited IRA over their own life expectancy, potentially allowing the remaining assets to continue growing tax-deferred for decades.

The SECURE Act went into effect in 2020 and significantly changed those rules.

Today, most non-spouse beneficiaries who inherit a traditional IRA must withdraw the entire account balance by the end of the 10th year following the original owner's death. Depending on the original owner's required minimum distribution (RMD) status and the beneficiary's circumstances, annual withdrawals may also be required during that period.

This creates a challenge that many families overlook: Your inheritance has a deadline, and the timing of your withdrawals can affect how much you ultimately keep.

If you inherit a traditional IRA, distributions are generally taxed as ordinary income. That means withdrawals may be added to your salary, business income, investment income, or other taxable income for the year.

Instead of receiving your inheritance tax-free, you could find yourself facing a series of tax decisions that affect your cash flow, retirement plans, and long-term financial goals.

Important: Rules differ for surviving spouses, eligible designated beneficiaries, Roth IRAs, and certain other situations. Your specific beneficiary status matters.

What could a $1 million inherited IRA actually cost you?

Imagine you're 50 years old living in Wisconsin, earning $150,000 annually, and you inherit a $1 million traditional IRA from a parent.

At first, it may feel like a financial windfall. But the tax implications could be more complicated than you expect.

If you withdrew approximately $100,000 each year for 10 years, that money would generally be added to your other taxable income. Your annual income could rise from $150,000 to $250,000 before accounting for deductions and other adjustments.

That additional income could push some of your dollars into higher federal and state income tax brackets, depending on your filing status and circumstances.

Consider the potential impact:

• A larger tax bill: Traditional IRA distributions are generally subject to ordinary income tax.

• Less take-home wealth: The amount you keep after taxes may be substantially less than the amount withdrawn.

• Fewer opportunities to control your income: Large distributions could affect other tax-sensitive financial decisions.

• A shorter planning window: Most non-spouse beneficiaries must empty the account within the applicable 10-year period.

The challenge isn't simply that taxes are due. It's that inherited IRA withdrawals can overlap with the income you're already earning.

For someone still working, a large distribution could mean paying more in taxes than if those withdrawals were coordinated with other financial decisions.

And the consequences aren't limited to a $1 million inheritance. Even a smaller inherited account can create an unexpected tax burden when combined with your regular income.

This is a hypothetical illustration, not an individual tax calculation. Actual results depend on federal and Wisconsin or your state tax laws, filing status, deductions, account characteristics, and withdrawal timing.

Why waiting until year 10 can backfire

One common assumption is that you can leave an inherited IRA invested for as long as possible, allow it to grow, and withdraw everything near the end of the 10-year period.

Although that approach may appear attractive, it can create a significant tax problem.

Imagine inheriting $500,000 and leaving the account invested for several years. If the balance grows, you may ultimately need to withdraw a much larger amount before the deadline.

A substantial withdrawal in the final year could push your taxable income significantly higher. If annual RMDs apply to your inherited IRA, you may also need to take distributions before that final year.

Waiting doesn't automatically reduce your tax liability. In some circumstances, it can concentrate the tax burden into a single year when your income is already elevated.

Alternative strategies may help mitigate tax risk. Depending on your circumstances, planning opportunities may include evaluating Roth conversions, coordinating retirement withdrawals, reviewing beneficiary designations, and considering alternative strategies (such as PATH: Passing Assets Tax-Free to Heirs) designed to help minimize tax risk for non-spousal heirs.

The goal is to make decisions with the full financial picture in mind, rather than letting a deadline dictate your strategy.

Three questions to ask before making inherited IRA decisions

You don't have to figure everything out the moment you inherit an account. But you should understand the rules before making major withdrawals or investment decisions.

1. When must the money be withdrawn?

Start by confirming which inherited IRA rules apply to you.

Your relationship to the original account owner, the date of death, the type of account, and whether the owner had reached the required beginning date for RMDs can all affect your distribution requirements.

Don't assume you have a full 10 years to wait before taking any distributions. Some beneficiaries must take annual RMDs during the 10-year period.

Understanding your deadline is the first step toward building a plan.

2. How will withdrawals affect my taxes?

Before taking a distribution, consider how it will affect your total taxable income for that year.

For example, withdrawing inherited IRA funds during a year when you are earning a full salary could produce a different tax result than withdrawing them during a lower-income year.

Your strategy should account for your other income sources, expected retirement date, state of residence, and any other relevant tax considerations.

A tax professional and a financial professional can help you evaluate different withdrawal schedules and understand the trade-offs.

3. What should I do with the money after taxes?

An inherited IRA distribution isn't the end of the financial decision. It's also the beginning of a new one.

Once taxes are paid on a taxable distribution, you may need to decide how to use or invest the remaining funds.

Will you use the money to support retirement? Pay off debt? Build a diversified investment portfolio? Create a source of future income? Or preserve more wealth for your own beneficiaries?

Your answer should reflect your financial goals, investment time horizon, liquidity needs, and comfort with risk.

The most effective approach considers both sides of the equation: how to manage taxes on the inherited account and how to put the remaining wealth to work.

Can you plan ahead to reduce the inherited IRA tax burden?

If you're preparing to leave retirement assets to your family, you have an opportunity to evaluate how those assets may affect your beneficiaries before the inheritance occurs.

Traditional IRAs and 401(k)s can be excellent retirement savings vehicles. However, their tax treatment doesn't end when the original account owner passes away.

Depending on your circumstances, planning opportunities may include evaluating Roth conversions, coordinating retirement withdrawals, reviewing beneficiary designations, and considering alternative strategies (such as PATH: Passing Assets Tax-Free to Heirs) designed to help minimize tax risk for non-spousal heirs.

Each option comes with potential costs, limitations, and trade-offs. For example, a Roth conversion generally requires paying taxes on the converted amount, so it should be evaluated against your current and future tax circumstances rather than treated as an automatic solution.

Alternative approaches may also be worth exploring if your goal is to help preserve more of your retirement savings for your family. PATH (Passing Assets Tax-Free to Heirs) is a planning strategy designed to help address the tax challenges associated with passing qualified retirement assets to non-spousal heirs.

As with any financial strategy, it's important to understand how an approach works, its associated costs and requirements, and whether it aligns with your goals and circumstances.

The important point is that planning before the money changes hands may give your family more options than waiting until an inherited IRA is already in your name.

Your inheritance deserves a strategy, not a surprise

An inherited IRA can represent years of hard work, disciplined saving, and a loved one's desire to provide for your future.

But the account's value is only part of the story. The tax rules governing that inheritance can influence how much wealth remains available for your own retirement, financial security, and family legacy.

The SECURE Act changed the rules for many beneficiaries, and the 10-year distribution requirement makes planning especially important. Without a clear understanding of the deadlines and potential tax consequences, you could make withdrawal decisions that unnecessarily reduce your after-tax wealth.

You don't need to make every decision at once. Start by understanding your inherited IRA rules, evaluating your potential tax exposure, and identifying the financial goals that matter most to you.

Then build a strategy around those goals.

Explore PATH: Passing Assets Tax-Free to Heirs

What if your retirement planning could account for not only your financial future, but also the taxes your loved ones may face when they inherit your assets?

PATH (Passing Assets Tax-Free to Heirs) is an alternative planning strategy designed to help address the tax challenges associated with transferring qualified retirement assets to non-spousal heirs.

If you're concerned about the impact inherited IRA taxes could have on your family, exploring alternative approaches may help you better understand the options available to you.

Request a free consultation to explore strategies tailored to you.

For informational and educational purposes. This information has been derived from sources believed to be accurate. Please note investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such.