When someone passes away in the US, their investments often pass to a beneficiary through one of two vehicles: a Transfer on Death (TOD) brokerage account or a beneficiary (inherited) IRA.
They can hold identical investments. They can come from the same person. Yet the tax treatment, the deadlines, and what you’re allowed to do inside each account could hardly be more different. Getting them confused is one of the most expensive mistakes a beneficiary can make.
A TOD brokerage account becomes yours outright, and the tax bill on past growth is largely wiped clean. An inherited IRA is a deferred tax bill with a 10-year fuse — every dollar comes out taxed, and the clock is ticking.
Same inheritance, two very different rulebooks. The TOD account rewards patience and gives you a clean slate; the inherited IRA demands a plan and punishes drift. If you’ve inherited both, they shouldn’t be managed with the same strategy — and the sequencing of withdrawals between them is often where the tax savings live.
The TOD brokerage account: a fresh start
A TOD account is simply a normal taxable brokerage account with a named beneficiary. At death, it bypasses probate and becomes your account.
The star of the show is the step-up in basis. The cost basis of every holding resets to its market value on the date of death. All the capital gains that built up during the original owner’s lifetime? Gone, for tax purposes. If you sold everything the week after the transfer, you would typically owe little or no capital gains tax.
From there, it behaves like your own money because it is. There is no deadline to withdraw, no penalty at any age, and you can add funds whenever you like. Withdrawing cash is not a taxable event — tax arises only when you sell an investment, and only on the growth since the date of death. The trade-off: dividends and interest are taxed each year, and every sale thereafter is reported on your tax return.
The inherited IRA: valuable, but on the taxman’s terms
An IRA never paid tax on the way in, so the tax is collected on the way out — from you. There is no step-up in basis. Every withdrawal from an inherited traditional IRA is taxed as ordinary income, at the same rates as salary, in the year you take it.
And you can’t simply sit on it. Since the SECURE Act, most non-spouse beneficiaries face the 10-year rule: the account must be fully emptied by 31 December of the tenth year after death. If the original owner had already started their required minimum distributions, you must also take annual minimum withdrawals in years one to nine. Miss one and the IRS penalties are steep.
There are compensations. The usual 10% early-withdrawal penalty for those under 59½ does not apply to inherited IRAs. And while money stays inside, it grows tax-free — you can buy and sell investments within the account without triggering any tax at all.
Two traps deserve special mention. First, you can never add money to an inherited IRA. Second, if you move it to another provider, it must go by direct trustee-to-trustee transfer. Take a cheque made out to you personally and the entire amount becomes taxable income immediately — there is no 60-day rollover for non-spouse beneficiaries, and no way to undo it.
Side by side
| TOD Brokerage | Inherited IRA | |
|---|---|---|
| Tax at inheritance | None — step-up erases past gains | None yet — but the bill is deferred, not erased |
| Tax on withdrawals | Only when you sell, at capital gains rates | Every dollar taxed as ordinary income |
| Deadline to empty | None | Generally 10 years (plus possible annual RMDs) |
| Early withdrawal penalty | None | None — the 10% penalty doesn’t apply |
| Trading inside | Every sale is taxable | Trades are tax-free inside the account |
| Adding money | Anytime | Never |
So what’s the smart play?
With the TOD account, there is usually no urgency. The step-up means selling soon after death costs little in tax, so you can take your time deciding whether the inherited portfolio actually suits you.
With the inherited IRA, the game is pacing. Take the whole balance in one year and you may catapult yourself into a much higher tax bracket. Spreading withdrawals sensibly across the 10-year window — coordinated with your other income — is often where real money is saved or lost.
The cross-border wrinkle
If you live outside the US — say, a UK resident inheriting from an American parent — an extra layer applies. The US/UK tax treaty, HMRC Reporting Status, HMRC’s treatment of IRA withdrawals, currency, and whether a US brokerage will even keep serving a non-US-resident beneficiary all come into play. Many US brokerages have been closing the door on expat account holders in recent years, which can force decisions on a timetable you didn’t choose. This is exactly the territory where cross-border advice earns its keep.
Comaprison infographic
TOD BrokeragevsInherited IRA
What happens to each account when you inherit it — in plain English.
Assumes a non-spouse beneficiary inheriting a traditional IRA (variations noted at the bottom).
None — and the step-up in basis erases capital gains that built up before death.
Nothing due immediately, but the tax bill isn’t erased — just postponed. No step-up.
Every withdrawal is taxed as ordinary income (like salary). No capital gains rates apply.
It’s just your money.
The usual 10% penalty does not apply to inherited IRAs.
Buy and sell freely with no tax on trades. Tax only hits when money leaves the account.
Contribute anytime, like any brokerage account.
You can never add money to an inherited IRA.
Only via direct trustee-to-trustee transfer. Never take a check made out to you — there’s no 60-day rollover, and it becomes fully taxable.
TOD Brokerage: low urgency
Selling soon after death usually means little or no tax, thanks to the step-up. There’s no clock ticking — decisions can wait.
Inherited IRA: pace yourself
Spread withdrawals across the 10 years so one giant lump doesn’t spike your income into a higher tax bracket. Don’t forget annual RMDs if they apply — penalties for missing them are steep.
- Spouse beneficiaries can roll the IRA into their own and escape the 10-year rule.
- Inherited Roth IRAs still face the 10-year rule, but withdrawals come out tax-free.
This is general information, not tax advice. Confirm specifics — especially RMD timing under the 10-year rule — with a qualified tax adviser.