Losing a family member is tough. And dealing with the financial side of their legacy - like an inherited IRA - can be overwhelming and confusing, especially as you are trying to juggle preparing for your own retirement, working and possibly still taking care of your own kids. If you inherited an IRA, say from your parents or grandparents, after 2019 the rules changed with the SECURE act and there is a big change you need to know about:
If you get this wrong, you could face a potential hefty tax bill along with penalties. Here I try to break it down in plain English and give you practical steps to make the most of your inheritance. As a CERTIFIED FINANCIAL PLANNER™ professional, I've helped folks navigate this situation many times before. Let's dive in.
If you inherited an IRA from your parent who passed away after December 31, 2019 you're likely subject to the 10 year rule (unless you're an eligible beneficiary like a spouse or minor child). This rule, introduced by the SECURE Act, says you have to empty the entire IRA by the end of the 10th year after their death. So, for example, if your father passed away in 2020 and he left his IRA to you as the beneficiary then you have until December 31st, 2030 to have the entire account emptied.
Here's the interesting part: you can take the money however you want during those 10 years - small chunks, large withdraws or all at once. However, if your parent was already taking RMDs (usually because they were age 73 older) then you have to keep taking RMDs each year during those 10 years.
Let's say you're 58 and you inherit a $200,000 IRA from your mom. You're busy and you figure, "I'll deal with it later. And you wait until year 10 to withdraw all $200,000. All that $200,000 is taxed as ordinary income and can potentially push you into a higher tax bracket, as well as various other tax thresholds, causing your inheritance to fell more like a tax problem than a blessing. For example, that $200,000 withdrawal could add an additional $50,000 in taxes depending on your federal tax bracket and state.
That's a big tax hit for 1 year.
But spread the withdrawals out over 10 years, say $20,000 per year, you might be able to stay in a lower tax bracket paying less in overall taxes.
At this stage in life you likely have several other priorities and goals you are balancing like saving for your own retirement, maybe helping kids or grandkids, traveling together as a family or planning for a vacation home. Mismanaging an inherited IRA can negatively impact your ability to stay on track towards these goals; however, with some planning you can minimize your taxes and make the inherited IRA work for you.
Not everyone is subject to the 10 year rule, there are some exceptions. If you're an "eligible designated beneficiary" (like a spouse or minor child) or someone with a disability you might have other options like stretching the withdrawals over your own lifetime. Spouses can actually just roll the inherited IRA into their own IRA, treat as their own IRA and be subject to RMDs based on their own age and life expectancy. But if you're in your 50s or 60s and inherited an IRA from your parents you're likely not an "eligible designated beneficiary". Be sure to check with your financial planner and tax professional because assuming you're an exception when you're not could lead to additional taxes and penalties.
First, figure out the 10 year deadline based on the year your parent passed away. If they died in 2022, then you have until December 31, 2032. Mark your calendar, set a timer or tell your advisor.
If your parent was taking RMDs (current RMD age is 73 but used to be 70 and 72 so double check this) you'll likely have to take annual RMD withdrawals as well. The IRS finalized this rule recently so don't assume you can skip withdrawals until year 10. Be sure to check with your advisor to see what your RMD is.
Clients that I have with inherited IRAs, I reach out to them and tell them what their RMD is and help them process their RMD withdrawal from the inherited IRA each year, that way they don't forget about it.
This is where it pays to do some planning. If you inherit your parent's IRA and they weren't taking RMDs then you have some options as far as when and how much to take out of the IRA. You can be strategic based on your income and tax situation as long as the entire balance of the IRA is withdrawn by the end of year 10. For example, if you know that you'll be in a lower tax bracket in a few years after inheriting the IRA then you could wait a couple years before taking any money out of the IRA to take advantage of the lower tax brackets. The important thing is to get some kind of plan in place because withdrawing from the IRA periodically over 10 years will likely be a better strategy than taking one huge lump sum in year 10.
If your parents were taking RMDs then your strategic options are a little more limited since you'll be taking RMDs yourself out of the inherited IRA. However, it's still important to pay attention to your tax situation to identify years where it may make more sense to take more than the RMD out in a given year.
At the end of the day getting an inheritance is a blessing so it needs to be looked at as an opportunity. The reason you want to make sure you pick the optimal withdrawal strategy is so that you pay as little tax as possible, keep more of the inherited IRA and make the money last for you and your family. Not all of the IRA money will be gone to taxes so think about how this inherited IRA fits into your current retirement plan and how it impacts your ability to achieve your goals.
You may be able to retire sooner than you thought, you may be able to spend more in retirement or you might be able to do both. The key is to not downplay the importance of the inherited IRA and make sure you take the time to do some planning to optimize your outcomes.
→ Missing the 10 year deadline:
Missing this deadline can trigger penalties and a rushed lump sum withdrawal that can increase your taxable income, your tax bracket and overall tax liability. This can lead to a domino effect impacting other areas of your finances like being able to contribute to a Roth IRA.
→ Forgetting annual RMDs:
Forgetting to take RMDs when you were supposed to take them is a costly, and unfortunately common, mistake. If you don't take those RMDs then you could potentially face a penalty of up to 25% of what should've been withdrawn. That's on top of the income tax that's due because every dollar withdrawn from the inherited IRA is subject to ordinary income tax.
Don't make this common mistake.
→ Not talking to a professional:
Don't try and wing it and try to do this on your own. This is when easily avoidable mistakes happen that cost you lots of money. If you've inherited an IRA, a conversation with a financial advisor or tax professional, like an EA or CPA, can potentially save you thousands.
Let's say in 2025 you're 52 years old and in the prime of your career. You're married with 2 kids. 1 of your kids is in college the other is still at home. Your income is high, expenses are high and you're in the 24% tax bracket. Both of your parents just passed away and you inherited $1,000,000 in IRAs from them and they were both already taking RMDs.
You'll need to continue taking RMDs each year and have the $1,000,000 completely emptied from the inherited IRAs by December 31, 2035. Any RMD, and other withdrawals, are taxed as ordinary income. If you don't take the RMDs out each year you can potentially be subject to an additional 25% tax on top of the ordinary income tax that's owed on what should've been taken out as an RMD. These RMDs will likely push you into the next tax bracket, 32%, and can impact your ability to do your Roth contributions for the years you take RMDs.
These RMDs might also impact your education planning for your child in college since your assets and income are both going to be higher over the next 10 years
The best way to look at this is that you have an additional $1,000,000 of income that you are able to realize over the next 10 years with some flexibility on how much you realize each year over the next 10 years.
Therefore, planning is critical here to see how this $1,000,000 impacts other areas of your finances and retirement planning.
Given the potential for making costly mistakes and the complexities involved in making the best decision for your situation, it's important to work with a professional if you're inheriting an IRA. Before you make any decision or move any money it's important to seek out the help and guidance of a professional to help you before any decisions are made. I've helped many clients before navigate inheriting an IRA and if you need help with yours and would like to discuss your situation feel free to to reach out to schedule a complimentary consultation.