Key Takeaways
- A Ramsey Show caller’s father-in-law died last month, and her husband’s inheritance could pay for the rest of college for the couple’s two youngest kids.
- If that inheritance is a traditional IRA, most heirs other than a spouse must empty it by the end of the 10th year after the death, so for a 2026 death the deadline is the end of 2036.
- The caller didn’t say how big the account is. On an assumed $300,000 IRA, even withdrawals would add $30,000 a year to the couple’s taxable income.
- Stock or a house works differently: the heir’s cost basis is its value on the day of death, so the gain built up over his father’s lifetime is never taxed.
If you’ve inherited money from a parent this year, its form can shape your tax bill as much as its size does. An IRA and a brokerage account worth the same amount on the day of death get taxed in very different ways.
A caller on the Oct. 27 episode of The Ramsey Show is dealing with exactly this. She and her husband have five grown kids. Each of the three oldest finished college with about $10,000 of student loans and paid it off in less than a year. Then she shared the news:
“My husband’s dad passed away last month and he will be receiving an inheritance so we could completely cover the cost of college for our two youngest kids.”
One of them has a year and a half of school left, and the other has three and a half. She called to ask whether paying for the two youngest would be unfair to the older three. The hosts told her it wouldn’t be.
She didn’t say what the inheritance is or how big it is. So let’s assume it’s a $300,000 traditional IRA, because that’s the kind of inheritance that comes with…a real deadline.
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The IRA has a deadline
The IRS’s Publication 590-B sets the rule for IRA owners who died after 2019: most heirs other than a spouse must take everything out by the end of the 10th year after the death. The IRS exempts a narrower group it calls eligible designated beneficiaries.
Her husband is inheriting from his father. Unless he’s in that exempt group, the 10-year rule applies to him, and a death in 2026 means the account has to be empty by the end of 2036.
The deadline is where the penalty comes in. Anything still in the account after 2036 owes a federal excise tax on top of the income tax. And if his father had already started his own required withdrawals, the heir also owes yearly withdrawals along the way.
Here’s what $300,000 does to a tax return
Every dollar taken out of a traditional IRA counts as taxable income in the year it comes out. If they spread the withdrawals evenly over the 10 tax years from 2027 through 2036, $300,000 works out to $30,000 a year ($300,000 ÷ 10) added to the couple’s return.
But college bills won’t wait 10 years. The younger kid finishes in about three and a half years. If the couple pulls the money out on the kids’ schedule, the withdrawals get bigger and fall into fewer years. The more taxable income they stack into one year, the more of it can land in a higher bracket.
Stock or a house gets a fresh start
If the inheritance is stock, a fund or a house, a different rule applies. The IRS’s Publication 551 says an heir’s cost basis is generally the property’s fair market value on the day the owner died.
So suppose his father bought shares decades ago and they were worth $300,000 when he died. The husband’s basis is $300,000. If he sells at that value, he has no taxable gain at all. The gain that built up over his father’s lifetime is never taxed, and only growth after the death is.
An IRA doesn’t get that reset. Money in a traditional IRA is taxed when it comes out, no matter who takes it out.
Which dollars to spend first
Within the 10 years, the heir has a lot of control over timing. Apart from any yearly withdrawals his father’s own schedule set off, he can take money out of the IRA in whatever amounts and years he likes, as long as it’s empty by the end of 2036.
A family that inherits both kinds of assets can pay the college bills by selling stepped-up assets, which can come with little or no taxable gain. They can then draw the IRA down over the full 10 years, so each year’s taxable withdrawal stays smaller.
The way I see it, the IRA is the money with both a clock and a tax bill attached, so it’s the money to plan around first. The kids’ tuition bills won’t change. What changes is how much of the inheritance the couple keeps after paying them.
Of course, all of this depends on what’s actually in the estate, and the couple may not know until it’s settled. The younger kid has three and a half years of school left, so there’s still time to work out which dollars to spend first.
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. Our analysis might not include recent company news or important updates. TIKR has no position in any of the stocks mentioned. Thank you for reading, and happy investing!
