The Tax Bill Your Beneficiaries Don’t See Coming

Most estate plans are judged by what they give away, and almost never by what the IRS takes back. A plan can route every asset to the right person, name the right trustees and guardians, and still hand the next generation a 6-figure income tax bill, because the largest asset in many estates, the retirement account, follows its own set of rules. Those rules changed in 2020 and tightened again in 2025, and plans drafted before the changes now work against the people they were built to protect.

The 10-Year Rule Ended the Stretch IRA

The SECURE Act eliminated the lifetime stretch for most non-spouse beneficiaries. Adult children who inherit a traditional IRA or 401(k) must now empty the account within 10 years.¹ Final IRS regulations issued in July 2024 added a second requirement, effective in 2025: when the original owner died on or after the date required minimum distributions began, beneficiaries must also take annual RMDs in years 1 through 9, then drain the balance by the end of year 10.^{1, 2} The IRS has waived penalties for missed distributions from 2021 through 2024 for reasonable cause. Enforcement began in 2025.²

A narrow class of eligible designated beneficiaries can still stretch distributions over life expectancy: surviving spouses, the owner’s minor children until age 21, disabled or chronically ill individuals, and anyone no more than 10 years younger than the decedent.¹ Most adult children face the 10-year clock.

Compressed Distributions, Compressed Brackets

The 10-year rule converts a lifetime income stream into a decade of forced income, usually landing in the beneficiary’s peak earning years. One published example: a $3 million traditional IRA split between 2 children can generate $750,000 to $1.1 million in federal income tax and push both heirs into the 32% to 37% brackets.³ In 2026, the top 37% rate starts at $640,600 for single filers and $768,700 for joint filers, and every inherited dollar stacks on top of the beneficiary’s own earnings.⁴

What Gets a Step-Up and What Does Not

Appreciated assets such as real estate and taxable brokerage accounts receive a step-up in basis at death under Section 1014 of the tax code, erasing the unrealized capital gain for heirs.⁵ Traditional IRAs, 401(k)s, and annuities receive no step-up. The law treats them as income in respect of a decedent, and every distributed dollar from a pre-tax traditional IRA and pre-tax 401(k) stays fully taxable.⁵ The contrast matters: the family home can pass nearly tax free while the retirement account beside it carries a built-in liability.

New York’s Estate Tax Cliff

Federal estate tax now reaches few families. The One Big Beautiful Bill Act set the exemption at $15 million per person and $30 million per couple beginning in 2026, indexed for inflation, with portability of any unused amount between spouses.⁶ New York is a different story. The state’s 2026 basic exclusion is $7,350,000, and it comes with a cliff. Once a taxable estate exceeds 105% of the exclusion, roughly $7,717,500, the entire exclusion disappears and the whole estate is taxed from the first dollar at rates of 3.06% to 16%.^{7, 8} A $7.15 million estate owes New York nothing. A $7.55 million estate owes roughly $497,200.⁸ New York also offers no portability, so an unused exclusion dies with the first spouse unless trust planning preserves it.⁹ On Long Island, a home, 2 retirement accounts, and a modest portfolio can cross that line without anyone noticing.

Planning Moves That Change the Outcome

Roth conversions during the owner’s lifetime shift the tax into the parents’ bracket, calibrated against the children’s expected future brackets rather than the parents’ current one, and hand heirs a tax-free asset (once the 5-year taxable year rule has been satisfied).³ Spreading inherited IRA withdrawals evenly across all 10 years avoids stacking income into 1 or 2 tax years. Credit shelter trusts preserve the New York exclusion at the first death. Life insurance supplies estate tax liquidity so heirs never sell the house or the business under pressure. Qualified charitable distributions and charitable remainder trusts redirect taxable IRA dollars toward the family’s giving goals instead of the IRS.

A Coordinated Approach to Beneficiary Planning

These moves cut across disciplines. The Roth conversion is a tax decision, the credit shelter trust is a legal document, and the insurance policy is a financial product, and they only deliver when they movetogether. Strata Alliance coordinates all 3, aligning estate planning attorneys  with tax and wealth management professionals  so the estate plan, the tax plan, and the investment plan point in the same direction.

If you need to update your estate plan or your beneficiaries stand to inherit retirement accounts, contact us to learn how our coordinated family office approach can help.

 

Endnotes

1. Grant Thornton, “Final RMD Rules Retain 10-Year Rule for Inherited Retirement Accounts,” July 30, 2024, https://www.grantthornton.com/insights/newsletters/tax/2024/hot-topics/jul-30/final-rmd-rules-retain-10-year-rule-for-inherited-retirement-accounts.

2. Ascensus, “The 10-Year Rule Is Here to Stay,” Mar. 17, 2025, https://thelink.ascensus.com/articles/2025/3/17/the-10-year-rule-is-here-to-stay.

3. Kurt Supe, “Three Powerful Forces Are Draining Family Wealth,” MarketWatch, June 17, 2026, https://www.marketwatch.com/story/the-great-wealth-transfer-is-real-but-the-irs-or-a-nursing-home-might-get-your-money-first-d0c46676.

4. Tax Foundation, “2026 Tax Brackets and Federal Income Tax Rates,” https://taxfoundation.org/data/all/federal/2026-tax-brackets/.

5. 26 U.S.C. Section 1014, https://www.law.cornell.edu/uscode/text/26/1014; see also 26 U.S.C. Section 691 (income in respect of a decedent), https://www.law.cornell.edu/uscode/text/26/691.

6. One Big Beautiful Bill Act, Pub. L. 119-21, Section 70106 (amending 26 U.S.C. Section 2010(c)(3)), signed July 4, 2025, https://www.congress.gov/bill/119th-congress/house-bill/1/text.

7. Brevy, “New York Estate Tax 2026: Exemption and the Cliff,” https://brevy.com/financial/new-york/estate-tax.

8. Kessler Fox Law, “Estate Planning After New York’s 2026 EPTL Updates,” https://www.kfoxlaw.com/post/estate-planning-after-new-york-s-2026-eptl-updates.

9. Inheritance Advisor Match, “New York Estate Tax: Exemption, the Cliff, and What Heirs Need to Know,” https://financial-advisors-for-inheritance.com/guides/new-york-estate-tax/.