Inherited Traditional IRA or 401(k) — Fully Taxable

When a beneficiary inherits a traditional IRA or 401(k), every dollar distributed is taxable as ordinary income — because the original contributions were made pre-tax and the growth was tax-deferred. The beneficiary pays income tax at their own marginal rate on each distribution.

Inherited Roth IRA — Tax-Free Distributions

Inheriting a Roth IRA is one of the best financial outcomes for a beneficiary — all distributions are tax-free, including all accumulated earnings, as long as the Roth IRA has been open for at least 5 years.

• Surviving spouse: Can roll into their own Roth IRA or treat as an inherited Roth IRA. No RMDs during their lifetime if rolled into their own account. Distributions are tax-free.
• Non-spouse beneficiary: Must distribute the entire inherited Roth IRA within 10 years — but every dollar of every distribution is completely tax-free. This makes an inherited Roth IRA significantly more valuable than an inherited traditional IRA of the same size.
• The 5-year rule: If the original owner opened the Roth IRA less than 5 years before their death, earnings on the inherited Roth IRA may be taxable until the 5-year period is satisfied. Contributions (basis) are always tax-free.

Inherited Taxable Brokerage Accounts — The Stepped-Up Basis Advantage

Inherited taxable brokerage accounts receive one of the most powerful tax benefits in the entire tax code: the stepped-up cost basis.

When you inherit stocks, mutual funds, ETFs, or other securities in a taxable account:

• Your cost basis is "stepped up" to the fair market value on the date of the deceased's death
• All pre-death appreciation is completely forgiven — you owe zero capital gains tax on gains that accumulated during the deceased's lifetime
• If you sell immediately after inheriting, you pay no capital gains tax at all (since your basis equals the sale price)
• Future gains from your date of inheritance onward are subject to capital gains tax at the applicable rate (0%, 15%, or 20%)

Inherited Savings Bonds — Ordinary Income Tax

U.S. Savings Bonds (Series EE and I) have deferred interest that becomes taxable when the bond is redeemed or matures. When a beneficiary inherits savings bonds:

• The accumulated interest is taxable as ordinary income — either in the year of the original owner's death (if the estate elects to report it) or when the beneficiary redeems or the bond matures
• No stepped-up basis — unlike stocks, bonds don't receive a stepped-up basis for the interest component
• State income tax treatment varies — some states exempt savings bond interest; others tax it

Tax Strategies for Non-Spouse Beneficiaries of Inherited IRAs

Under the 10-year rule, the timing of distributions within the 10-year window is entirely flexible — and that flexibility is the primary tax planning lever:

• Spread distributions across multiple years. Rather than taking a lump sum in year one (which could push you into the highest brackets), distribute over 10 years in amounts that stay within your lower brackets.
• Take larger distributions in lower-income years. If you have a year with significant deductions, business losses, or lower earned income, that's an ideal year to take a larger inherited IRA distribution.
• Coordinate with other income sources. Model the distribution alongside your other income — salary, Social Security, investment income — to identify the optimal annual amount each year.
• Take no distributions until year 10 if that's most tax-efficient. Some beneficiaries in high income years prefer to defer all distributions to later years when income may be lower. The account can continue growing tax-deferred until then.

Common Mistakes

• Taking the entire inherited IRA as a lump sum. A $400,000 inherited IRA taken as a lump sum generates $400,000 of ordinary income in a single year — potentially pushing the beneficiary into the 35–37% bracket. Spreading distributions over the 10-year window can save tens of thousands in taxes.
• Failing to take required distributions and missing the 10-year deadline. If the 10-year distribution deadline is missed, the IRS imposes a 25% excise tax on the remaining balance. Plan and calendar distribution deadlines carefully.
• Gifting appreciated securities instead of holding them until death. When you gift appreciated stock during life, the recipient inherits your original cost basis — and owes capital gains tax on all pre-gift appreciation when they sell. If you hold the stock until death, the recipient gets a stepped-up basis and owes no capital gains on that appreciation.
• Not consulting a tax advisor before taking any distributions. The optimal distribution strategy for an inherited IRA depends entirely on the beneficiary's income, tax bracket, other sources of income, and time horizon. Generic rules don't apply — custom planning does.
• Treating inherited Roth and traditional IRAs the same. They are dramatically different tax situations. An inherited Roth IRA requires no income tax planning — just meeting the 10-year distribution requirement. An inherited traditional IRA requires careful multi-year tax planning.

Real-Life Example