How Do I Minimize Paying Taxes on an Inherited IRA?

Inheriting an IRA can be a boon, but it’s crucial to understand the tax implications of such a situation. Traditional IRAs offer tax-deferred growth, with taxes due when money is withdrawn. Roth IRAs are funded with after-tax dollars, allowing for tax-free withdrawals under qualifying conditions.

However, inherited IRAs come with their own set of rules that can potentially impact your tax situation.

Navigating Tax Implications

Distributions from a traditional IRA that’s inherited are subject to your ordinary income tax rates, which could bump you into a higher tax bracket. Unlike the original owner, beneficiaries are exempt from the 10% early withdrawal penalty, regardless of age. Spousal beneficiaries have the option to treat the IRA as their own, deferring RMDs until age 73.

Roth inherited IRAs offer tax-free withdrawals if they’re qualified distributions, meaning the account has been funded for at least five years. Non-spousal beneficiaries must withdraw the entire amount within 10 years, with certain exceptions for disabled or underage beneficiaries.

Strategic Withdrawals

You may want to consider spreading your withdrawals from an inherited IRA over several years rather than taking a lump sum. This can be particularly advantageous if you anticipate being in a lower tax bracket in the future. For non-spousal beneficiaries required to empty the account within 10 years, timing withdrawals to coincide with years of lower income can reduce that tax burden.

For inherited Roth IRAs with funds less than five years old, waiting until the five-year mark can ensure the tax-free withdrawal of investment earnings. Original owners might consider converting traditional IRAs to Roth IRAs if they’re in a lower tax bracket than their beneficiaries, allowing for tax-free inheritance.

Non-spousal beneficiaries cannot delay RMDs and must withdraw the entire balance within 10 years, with exceptions for those who are disabled, chronically ill, minors, or not more than 10 years younger than the original owner. Ready to tackle the potential tax implications of your inherited IRA? Let’s plan your strategy. Contact me or schedule a meeting today.