Inherited IRA Investment Strategy

How to invest the account during the SECURE Act 10-year window — and why the rules are different from your own portfolio.

All distributions are ordinary income — no capital gains preference

Inside any traditional IRA, all investment returns — dividends, interest, capital gains — grow tax-deferred and exit as ordinary income when distributed. Whether your inherited IRA holds dividend stocks, bond funds, or a growth equity index, every dollar you take out is taxed at your ordinary income rate. There is no preferential long-term capital gains rate on qualified dividends or appreciated securities inside the account.¹

This matters for investment selection. In a taxable brokerage account, holding tax-efficient equities (low-turnover index funds) preserves the long-term capital gains rate. Inside the inherited IRA, that distinction disappears — a REIT fund, a high-dividend stock, and an S&P 500 index are all taxed identically at distribution. The only variable is how much growth happens before you're forced to take the distribution.

Practical implication: you can hold asset classes in the inherited IRA that you'd prefer to shelter in a tax-deferred account — higher-turnover investments, REITs, taxable bonds — without concern about generating short-term gains. What you cannot do is hold any asset long enough to benefit from preferential rates at sale, because there is no preferential rate.

The bucket approach: match duration to distribution year

The most disciplined framework for investing an inherited IRA is a segmented bucket strategy. Because you know the 10-year endpoint, you can build a portfolio where each segment covers a specific distribution window:

Each year, you draw from the near-term bucket and refill it by moving assets down from the mid-term bucket — and eventually from the long-term bucket into mid-term. This is the same mechanics used in retirement income buckets, adapted for the mandatory 10-year distribution timeline.

Liquidity requirements when annual RMDs are mandatory

For accounts where the original owner had already started Required Minimum Distributions (died after their Required Beginning Date — age 73 for those born 1951–1959, age 75 for those born 1960 and later), the T.D. 10001 final regulations require annual RMDs from the inherited IRA in years 1–9, not just full depletion by year 10.²

In these cases, the near-term bucket must be sized to cover the annual RMD floor — calculated using the Single Life Expectancy Table in IRS Publication 590-B. Missing a required annual distribution triggers a 25% excise tax on the shortfall (reducible to 10% within the correction window under SECURE 2.0 § 302).³

If your inherited IRA is primarily invested in equities and markets drop 30% the year your mandatory RMD is due, you face a forced sell at a low — and lose the recovery upside on the sold shares. Sizing the near-term bucket to cover at least 12–18 months of required distributions avoids this forced-sale problem.

The year-10 sequence-of-returns trap

The most expensive investment mistake beneficiaries make is deferring: leaving the balance as large as possible to "let it grow," then taking a large lump-sum distribution in year 10. This is problematic for two reasons.

Tax concentration. A $500,000 inherited IRA growing at 6% becomes roughly $895,000 in year 10. Taking the entire amount in one year — on top of your salary, Social Security, and any own-account RMDs — can push substantial dollars into the 32–37% bracket.⁴ See inherited IRA tax strategies for the full bracket analysis.

Sequence-of-returns exposure. If you've deferred heavily and markets fall 35% in year 9, you're taking a $580,000 distribution (down from what would have been $895,000) at an inopportune time — with no option to wait for recovery. The mandatory endpoint removes the single most important tool for managing sequence-of-returns risk: flexibility about when to sell.

The structural solution is to take distributions earlier in the window during high-income years where the marginal cost is lower, and to de-risk the remaining balance as year 10 approaches. This is mechanically similar to a bond glide path in target-date funds — gradually reducing equity exposure as the distribution deadline approaches.

How investment allocation interacts with your tax plan

The inherited IRA doesn't exist in isolation — you likely also have a taxable brokerage account, a Roth IRA, and a traditional 401(k) or IRA of your own. The question of what to hold where matters more than any single account's allocation.

Two specific interactions:

Roth conversion coordination. If you're coordinating Roth conversions from your own IRA during the inherited IRA 10-year window (as described in the Roth Conversion Coordinator), the dollar amounts taken from the inherited IRA each year affect how much bracket room remains for conversions. Higher inherited IRA distributions → less room for own-IRA Roth conversions. A specialist models both simultaneously rather than optimizing each in isolation.

Asset location. Within your overall portfolio — not just the inherited IRA — the question of which assets belong where still applies. Tax-inefficient assets (high-turnover funds, taxable bonds generating ordinary income) are better held in tax-deferred accounts. Tax-efficient assets (buy-and-hold equity index funds generating mostly unrealized gains) belong in taxable accounts where you get the step-up in basis and preferential capital gains rates. Because the inherited IRA is already earmarked for distribution within 10 years, it may be the right location for bond holdings or dividend-heavy assets that would otherwise generate current taxable income in a brokerage account.

Common investment mistakes with inherited IRAs

Too conservative across the board. Many beneficiaries move the entire inherited IRA to money market or CDs out of fear of "losing the inheritance." This is understandable but costly. If a $500,000 account earns 2% for 10 years (total ~$610,000), versus 6% for 10 years (total ~$895,000), the difference in total distributions — all ordinary income — is roughly $285,000 gross. After tax at 24%, that's approximately $217,000 in additional after-tax wealth from a more appropriate allocation.

No liquidity plan for annual RMDs. Beneficiaries in post-RBD accounts who hold everything in equities face forced selling when the annual RMD is due. A single large down year can permanently impair the account's remaining value.

Neglecting the year-10 de-risking transition. Appropriate equity allocation in year 1 is not appropriate in year 8. As the mandatory endpoint approaches, the portfolio should shift toward more stable assets — otherwise you're accepting sequence-of-returns risk with no ability to manage it.

Optimizing the inherited IRA in isolation. The right investment strategy for the inherited IRA depends on what else is in the portfolio. A beneficiary with $2M in Roth IRAs and zero taxable income most years can afford to be more aggressive in the inherited IRA (and should front-load distributions in low-bracket years). A beneficiary already in the 37% bracket has different tradeoffs. The inherited IRA's investment strategy should follow the tax strategy, not lead it.

What a specialist models for you

A fee-only inherited IRA specialist builds a year-by-year plan that integrates: annual distribution amounts (optimized by bracket), investment allocation by year segment, RMD calculations if required, Roth conversion coordination from your own IRA, and market-scenario stress tests for the near- and mid-term buckets. The goal is to maximize after-tax value across the full 10-year window — not just to avoid losing the principal in any single year.

Generalist advisors who aren't familiar with the SECURE Act's mechanics often either (a) default to equal annual distributions with no investment structure, or (b) defer everything to year 10 and leave the bracket concentration problem unaddressed.

Sources

1. IRC § 408(d)(1) — Distributions from IRA treated as ordinary income. All distributions from a traditional IRA (including an inherited traditional IRA) are included in gross income as ordinary income in the year distributed.
2. T.D. 10001 — Final Regulations on Required Minimum Distributions (July 2024). Annual RMDs required in years 1–9 for non-EDB beneficiaries when decedent died after Required Beginning Date. Effective beginning January 1, 2025.
3. IRS — RMD FAQs: SECURE 2.0 § 302 excise tax reduction. Missed RMD penalty: 25% of shortfall; reduced to 10% if corrected within approximately 2 years.
4. IRS Rev. Proc. 2025-32 — 2026 inflation-adjusted tax parameters. 2026 ordinary income brackets: 32% on taxable income $201,775–$256,225 (single), 35% on $256,225–$640,600, 37% above $640,600.
5. IRS Publication 590-B — Distributions from IRAs. Single Life Expectancy Table used to calculate annual RMD for inherited IRA beneficiaries; beneficiary distribution rules for inherited accounts.

Tax values verified against 2026 sources as of May 2026. Inherited IRA investment strategy is highly fact-specific — the optimal allocation depends on your income trajectory, other assets, bracket, and whether annual RMDs are required. This page is informational only; consult a qualified advisor before acting.