Retirees Planning to Leave IRAs to Their Heirs Need to Know About This New IRS Rule

If you're considering leaving your children money, you're probably in a better financial position than most. But it’s important to know all the rules and restrictions around doing so — and why a monetary inheritance may not always be the best idea.

After years of uncertainty, the IRS finalized rules clarifying that beneficiaries who inherit retirement accounts — including 401(k)s, IRAs, and other pre-tax contribution plans — after Jan. 1, 2020, have 10 years to deplete those funds.

The rule doesn’t apply to eligible designated beneficiaries (EDBs) such as spouses, minor children, those not more than 10 years younger than the deceased, and disabled or chronically ill beneficiaries.

Previously, heirs could take smaller distributions over their lifetimes, allowing retirement accounts to grow. While the SECURE Act 2.0, enacted in 2019, changed this, it left unanswered whether heirs needed to withdraw annually or could wait until the end of the ten years.

Though the amounts vary, the IRS has mandated annual withdrawals, providing clarity for heirs since 2020.

"You can take the money outvhowever you want during those ten years — all at once, in chunks, or spread it out — but it must be gone by the end of the tenth year," Gloria Garcia Cisneros, a Los Angeles-based certified financial planner, told Yahoo! Finance. "This is a big change from the old rules."

This change ends the "stretch" IRA strategy, where beneficiaries took minimal distributions over their lifetimes, extending the tax-deferred status. The new rules affect adult children, grandchildren, siblings, friends, and others who don't qualify as EDBs.

Even if you’re not likely to inherit money, you’re probably still determined to help your children build a stable foundation for their future . With that in mind, the best inheritance might not be monetary — instead, it could be a combination of instilling industry and compassion, with any cash gifts playing a supplementary role.

Read on for 15 thought-provoking reasons to reconsider giving a direct inheritance.

1. You want your kids to have a good work ethic

Poverty is hard, but prosperity has its pitfalls too. Self-made rich people want their children to acquire the work ethic needed to amass wealth.

As one famous example, actor Jackie Chan has willed half his fortune to charities and said his son gets nothing. “If he is capable, he can make his own money,” said Mr. Chan. “If not, he will just be wasting my money.”

No one wants their children to struggle through life. But the ability to earn money and learn to manage it may be a better inheritance than the money itself.

2. No attitude of entitlement

No one wants to raise a bad nut like Roald Dahl’s Veruca Salt. Or young Texan Ethan Couch, whose lawyers successfully used his family’s wealth as the “affluenza” defense at his trial for killing four people while driving drunk.

While Veruca Salt and Ethan Couch are extreme cases, curtailing a child’s inheritance sets limits.

That’s one reason actor parents Mila Kunis and Ashton Kutcher intend to leave their $265 million fortune to charities, not their kids. Says Kutcher, “My kids are living a really privileged life, and they don’t even know it.”

He and his wife insist on raising non-spoiled children and limit their kids to one Christmas gift per year to cultivate gratitude over entitlement.

3. Most inherited wealth gets squandered

If your adult children do a poor job of managing their money now, giving them a fistful of cash in the future won't magically solve their problems.

One in three Americans who receive an inheritance blows it. Within two years, most inheritors have negative savings and are worse off than before.

And research shows that 90% of families inheriting wealth lose their money by the time it reaches the third generation.

4. Estate taxes

Inheritance taxes can take 40% of your money before it ever reaches your children. But there are measures you can take to preserve those assets.

Gifting children money now to avoid estate taxes later is common practice for wealthy people. You can gift your children up to $17,000 a year tax-free or $34,000 yearly if they’re married.

People can also reduce tax liability by creating donor-advised funds (DAFs), life insurance, family LLCs, or generation-skipping trusts (GSTs).

But gifting money every year to kids now is the biggest trend financial advisors are seeing. They don’t want to wait until they’re dead to give their children money.

5. You child’s future ex

If you’re on the fence about giving your adult child an inheritance, you probably don’t want to leave a gift for an ex-spouse. Yet that possibility is a coin-flip away.

Forty-three percent of Americans will wind up divorced at some point, and property is usually evenly split. So if you leave your 35-year-old son money and he divorces eight years later, half of those funds are going to the ex.

Not giving your child an inheritance is one way to avoid this 43% likelihood.

6. Vulnerability to gold diggers

People who get sued are worth suing, and a large inheritance makes your child ripe pickings. You don’t want inheritance money to put a bullseye on your children.

There are many examples of a lawsuit wiping out someone’s inheritance because of frivolous claims or the person’s accidental negligence — think dog bites, car accidents, or swimming pools.

7. Possibility of bankruptcy

Your child’s future misfortunes may be another reason to think twice. Roughly 400,000 personal bankruptcies are filed every year in the United States. The majority (66.5%) are due to medical bills or job loss.

And whether the bankruptcy is due to forces beyond your child’s control, or poor choices on the part of your child, you don’t want your money going to federal bankruptcy courts.

8. Market volatility

An inheritance may be subject to the volatility of the market. A $500,000 inheritance today may be whittled down to $250,000 if the S&P; 500 crashes.

That’s how the Vanderbilts, once one of America’s wealthiest dynasties, went bust. The entire fortune was gone within 50 years of Cornelius Vanderbilt’s death.

The grandson’s 10 palatial residences in Manhattan didn’t help, but the Vanderbilts essentially lost their fortune due to poor investments.

Your money is subject to market conditions at any time, and you need to protect your future before taking care of your heirs.

9. Sacrificing your future

Parents feel honor-bound to leave something, or at the least avoid sticking their children with a funeral bill.

But parents should secure their own housing, health, and general well-being before they can think of leaving a monetary gift to others. And many wealthy people are doing just that.

Parents give their children all kinds of opportunities to succeed, and it’s up to them to work hard and develop their sense of worth and accomplishment.

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10. Warm money is better than cold money

Warm money is money you give your children from their intended inheritance while you are still alive. Cold money is the money inherited after you have passed.

Some parents may find the practice insensitive and distasteful. But other parents, like Kim Opitz of Minneapolis, Minnesota, have a more pragmatic outlook.

Opitz, a business owner and mother of three, isn’t opposed to leaving an after-death legacy, but right now, she and her husband aren’t thinking that far ahead.

“Inheritance right now isn’t the priority,” says Opitz. “My priorities are helping them graduate [college] or obtain an education with the least amount of debt.”

While Opitz hopes to be in a position one day to offer cash gifts and a traditional inheritance, work ethic and employability are what she and her husband primarily strive to pass down.

11. Guardrails breed resentment

Many well-meaning parents establish trusts prioritizing upright behavior, such as marriage, children, and gainful employment.

For example, there are income match trusts where beneficiaries withdraw funds that match their earnings. But if one sibling is a surgeon and the other is a teacher, there are going to be hard feelings.

Additionally, it may thrust your children into a lucrative line of work — like investment banking — instead of a lower-paid calling like social work or nursing. And beyond all the resentment bred, these guardrails don’t always work.

12. Family strife

Do you want your adult kids to fight with their stepmother and never talk to her again? Or for your eldest daughter, appointed trustee, to be sued by her siblings? Then, by all means, throw piles of cash at your family after you die.

These in-family inheritance disputes happen every day, and your family may be as vulnerable as the next. Some experts say that inheritance destroys a family more than half the time.

When inheritances don’t go as the heirs expect, it creates feelings of distrust. To avoid this, advisors suggest that the parents write a “letter of intention” to the heirs so that they understand who gets what and why.

This can lessen the anger that comes with an inheritance but may not eliminate it.

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13. Charities may be better served

Increasingly, wealthy people are choosing to donate their wealth to charities. Mark Zuckerberg, Bill and Melinda French Gates, and Warren Buffett are three noted examples.

In fact, Buffett and the Gateses created the Giving Pledge to encourage the ultra-wealthy to donate their money to charities.

Society overall may be better served by helping broader swaths of people. And on a practical note, it eliminates the politics, in-fighting, and sometimes curse of inherited wealth.

14. It’s bad for the country

There’s a growing group of Americans who want to pay more taxes and leave their children with a slim if any, inheritance.

The group is called “Patriotic Millionaires.” They’re concerned that wealth concentrated in a tiny percentage of the population is bad for the country. The group contends it’s destabilizing and propagates continual inequity.

One noted member is Scott Nash, founder of East Coast grocery chain MOM’s Organic Market. Nash has shared his intent to leave his children very little — enough to cover the “basics” but “never so much that they don’t have to work.”

15. A legacy of helping others

Many super-rich parents, including Simon Cowell and Bill Gates, would rather leave their children a legacy of helping others instead of the curse of wealth.

The inherited money, said Gates, would “distort anything they might do” with his fortune instead “dedicated to helping the poorest.”

Cowell is also against “passing on [wealth] from one generation to another” but favors helping people and providing “an opportunity so that they could do well.”

Bottom line

Over the next two decades, over $80 trillion in wealth is estimated to be passed down from baby boomers to their heirs.

But there are many thoughtful reasons to consider leaving no inheritance or capping your share of the $80 trillion pie at a sensible sum.

Curtailing an after-death inheritance to a reasonable amount — enough to prepare them financially — may be the best approach. But where to draw the line between “just enough” and “too much” is the perennial, million-dollar question.

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