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If you’ve inherited a pretax individual retirement account since 2020, you could face a sizable tax bill without proper planning, experts say.
Previously, heirs could take inherited IRA withdrawals over their lifetime, known as the “stretch IRA.”
However, the Secure Act of 2019 enacted the “10-year rule,” which requires certain heirs, including adult children, to deplete inherited IRAs by the 10th year after the original account owner’s death.
But waiting until the 10th year to make IRA withdrawals “could mean sitting on a tax bomb,” said certified financial planner Ben Smith, founder of Cove Financial Planning in Milwaukee.
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Pretax IRA withdrawals incur regular income taxes. The 10-year rule can mean higher yearly taxes for certain heirs, particularly for higher earners with bigger IRA balances.
Shortening the 10-year withdrawal window can compound the issue, experts say.
Larger withdrawals can significantly boost your adjusted gross income, which can have other consequences, such as higher capital gains tax rates or phaseouts for other tax benefits, Smith said.
For example, Smith has seen people lose eligibility for the electric vehicle tax credit, worth up to $7,500, by taking a large inherited IRA withdrawal in a single year.
Required withdrawals for inherited IRAs
Since 2019, there’s been confusion over whether certain heirs needed to take yearly withdrawals, known as required minimum distributions, or RMDs, during the 10-year window.
After years of waived penalties, the IRS finalized RMD rules for inherited IRAs in July.
Starting in 2025, certain beneficiaries — heirs who are not a spouse, minor child, disabled, chronically ill or certain trusts — must begin taking yearly RMDs from inherited IRAs. The RMD rule applies if the original account owner reached their RMD age, or “required beginning date,” before death.
Starting in 2020, the Secure Act raised the required beginning date for RMDs to age 72 from 70½. But Secure 2.0 enacted two increases: RMDs beginning at age 73 starting in 2023, and age 75 in 2033.
IRA withdrawals are ‘a matter of timing’
Even if RMDs aren’t required, heirs should still consider spreading out inherited IRA withdrawals, experts say.
“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,” according to CFP Carl Holubowich, principal at Armstrong, Fleming & Moore in Washington, D.C. “That money will be taxed at some point, it’s just a matter of timing.”
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.
Carl Holubowich
Principal at Armstrong, Fleming & Moore
Some heirs may consider bigger inherited IRA withdrawals in lower-income years during the 10-year window or other tax-planning strategies, experts say.
Future income tax brackets
Individuals may also consider future federal income tax brackets, IRA expert and certified public accountant Ed Slott previously told CNBC.
Without changes from Congress, dozens of individual tax provisions, including lower federal income tax brackets, will sunset after 2025. That would revert rates to 10%, 15%, 25%, 28%, 33%, 35% and 39.6%.
“Every year you don’t use [the lower brackets] is a wasted opportunity,” Slott said.
But with control of the White House and Congress uncertain, it’s difficult to predict whether the federal tax brackets will change after 2025.
