A 62-year-old in New Jersey posted on Bogleheads earlier this year asking a simple question. Her father had died with a $750,000 401(k) and named her the sole beneficiary. Her CPA told her to roll it into an inherited IRA and take it out slowly. Her brother’s advisor told him to take his half of a similar account as a lump sum and get the taxes over with. Only one of them was right.
The wrong answer, repeated in tax offices across the country every spring, will quietly cost heirs close to $120,000 more than it needs to. The mistake sits inside a rule most beneficiaries have never read.
The 10-Year Rule Has Teeth
Under SECURE Act rules now fully in force, most non-spouse beneficiaries of a 401(k) or IRA must empty the account by December 31 of the tenth year following the original owner’s death. If the decedent had already begun required minimum distributions, annual withdrawals are also required in years one through nine.
Every dollar coming out is taxed as ordinary income to the beneficiary. There is no step-up in basis. There is no capital gains treatment. A 401(k) that grew tax-deferred for 30 years hits the heir’s return at their marginal rate, stacked on top of their salary. That last part is where the six-figure mistake lives.
The Lump Sum Trap in Real Numbers
Consider a married beneficiary earning $150,000 jointly with her spouse. In 2026, the standard deduction for married couples filing jointly is $32,200, and the 24% bracket runs from $211,400 to $403,550, with 32% kicking in above that, 35% over $512,450, and 37% above $768,700.
Take the $750,000 in one shot and household taxable income leaps toward $868,000. Big slices are carved off at 32%, 35%, and 37%. Federal tax on the inherited portion alone lands near $255,000 before state income tax.
Spread the same $750,000 evenly over the full 10 years at $75,000 a year, and taxable income stays around $193,000. The inherited money is taxed almost entirely at 22% and 24%. Federal tax on that portion falls closer to $135,000. The gap sits right around $120,000 in federal tax alone.
Why the Delay Also Pays
Every dollar left inside the inherited IRA keeps compounding tax-deferred. With the 10-year Treasury yielding almost 4.6% and cash rates anchored to a federal funds rate of 3.75%, the balance left inside the wrapper earns real yield the beneficiary would otherwise hand to the IRS. The goal is to level the withdrawals so each year’s slice lands in the lowest bracket possible. Stalling until year 10 and bunching everything into one return simply recreates the original problem.
Where the Cascade Gets Worse
A lump sum does more than push a beneficiary into the 37% bracket. It can pull a retired heir over IRMAA thresholds two years later, triggering Medicare Part B and D surcharges of several thousand dollars per person. It can turn 85% of that year’s Social Security into taxable income. It can push the household out of the 0% long-term capital gains rate on other investments. Every one of these downstream costs disappears when the withdrawal is spread.
Three Moves Before Year One Closes
- Retitle the account correctly. A non-spouse beneficiary must move the balance into an inherited IRA titled as [Decedent’s Name], deceased, IRA FBO [Beneficiary Name]. Cashing the check or rolling it into your own IRA is treated as a full taxable distribution and the mistake cannot be reversed.
- Model a 10-year withdrawal schedule against your bracket. Take enough each year to fill the 22% or 24% bracket without spilling into 32%. If a low-income year appears (early retirement, a sabbatical, a business loss), pull more that year and less the next.
- Confirm whether annual RMDs are required inside the window. If the original owner died after their required beginning date, the IRS requires annual withdrawals in years one through nine. Skipping them carries a 25% penalty on the missed amount, cut to 10% if corrected quickly.
The 401(k) a parent built was designed to fund a retirement. Ten years is a long runway. Use every year of it.
Contact [email protected] for any questions or corrections.
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