Rosalind Evans
Inheriting a pre-tax individual retirement account (IRA) can seem like a financial windfall, but if not handled carefully, it could trigger a significant tax burden. Since the Secure Act of 2019, experts have warned that inherited IRA holders must plan their withdrawals wisely to avoid falling into what some call a “tax bomb.”
The 10-Year Rule: What Has Changed?
Before 2020, heirs could take out inherited IRA distributions over their lifetime, known as the “stretch IRA.” However, with the introduction of the Secure Act in 2019, a new “10-year rule” was implemented, requiring heirs, such as adult children, to withdraw the entire balance of the inherited IRA within ten years of the original owner’s death.
Ben Smith, certified financial planner and founder of Cove Financial Planning in Milwaukee advises caution: “Waiting until the 10th year to make IRA withdrawals could mean sitting on a tax bomb.”
Why Timing Matters: The Impact of Large Withdrawals
Those amounts are taxed as ordinary income when you withdraw from a pre-tax IRA. Spreading out withdrawals over several years could help manage the tax bill, but if you wait and take a large withdrawal in the 10th year, this could significantly increase your adjusted gross income.
“Larger withdrawals can push you into higher tax brackets and cause phaseouts for other tax benefits,” Smith explained. This could even affect unrelated areas of your finances, such as your eligibility for credits like the electric vehicle tax credit, which is worth up to $7,500.
Required Minimum Distributions (RMDs): What You Need to Know
The IRS recently clarified its stance on required minimum distributions (RMDs) for inherited IRAs. Starting in 2025, certain heirs—excluding spouses, minor children, and a few other exceptions—will be required to take yearly RMDs from inherited IRAs if the original account owner has reached their “required beginning date.” This requirement adds another layer of complexity for heirs managing their tax planning.
The Secure Act 2.0 has also adjusted the required beginning date, raising it to age 73 starting in 2023 and 75 in 2033, giving additional time for tax planning for future beneficiaries.
The Power of Timing: Managing Withdrawals Smartly
Even if heirs are not required to take annual RMDs, experts recommend carefully considering the timing of their withdrawals. “If you decide not to take a distribution from an inherited IRA in a year and it continues to grow, the tax bill increases right along with it,” said Carl Holubowich, a certified financial planner at Armstrong, Fleming & Moore in Washington, D.C. “That money will be taxed at some point, and it’s just a matter of timing.”
Tax planning strategies, such as taking larger withdrawals during lower-income years, can help manage the overall tax burden.
Future Tax Brackets: A Key Consideration
Another critical factor is the future of federal tax brackets. Certified public accountant Ed Slott points out that federal income tax rates are set to change after 2025 unless Congress acts. “Every year you don’t use [the lower brackets] is a wasted opportunity,” Slott said. If tax rates increase, the potential for an even larger tax bill in the future grows.
Strategic Withdrawal Planning Is Essential
Inheriting an IRA has significant tax implications, but proper planning can minimize the burden. Whether you’re facing RMDs or considering the timing of withdrawals, understanding your options is critical. As Ben Smith emphasized, “With a well-thought-out plan, you can avoid sitting on a tax bomb.”
