If you’ve inherited an IRA in recent years, you may be looking forward to the financial boost it can provide. However, new IRS rules could make the process more complex, with potential tax implications that need careful planning.
The IRS has clarified that most beneficiaries must now withdraw all inherited IRA funds within 10 years, meaning some could face significant tax burdens in certain years.
The 10-Year Rule
The 10-year withdrawal rule was introduced by the SECURE Act 1.0 in 2019 but hadn’t been strictly enforced until recently. Before this change, heirs could “stretch” their IRA withdrawals over their lifetime, which helped reduce annual taxes.
Now, unless you are a surviving spouse, minor child, disabled, or less than 10 years younger than the original account holder, you are required to empty the inherited IRA within a decade.
This rule can cause larger tax bills for beneficiaries, particularly if the funds are withdrawn in high-income years.
It’s important to note that if the original account holder had started taking required minimum distributions (RMDs) before death, the beneficiary must continue those annual distributions. If the account holder hadn’t started RMDs, you could wait and withdraw all the funds by the end of the 10-year period.
How Withdrawals Are Taxed
How much you’ll owe in taxes depends on the type of IRA you inherit. Withdrawals from a traditional IRA are taxed as ordinary income.
This could push you into a higher tax bracket, especially if the distributions are large.
If you inherit a Roth IRA, you’re in luck—distributions are tax-free. However, you’ll still need to deplete the account within 10 years if you’re not exempt from the rule.
Planning for Future Tax Brackets
Many tax provisions passed under former President Donald Trump, including lower federal income tax brackets, will expire after 2025.
That means tax rates will revert to higher levels unless Congress steps in. This could impact your tax burden significantly when withdrawing from an inherited IRA.
Beneficiaries can minimize taxes by spreading withdrawals over the 10-year period. This strategy helps keep your income within lower tax brackets and avoids sudden spikes in taxes.
For those expecting changes in their income—such as a job change, retirement, or family planning—timing your withdrawals to match lower-income years can also reduce taxes.
Impact on Social Security, Medicare, and Student Loans
If you receive Social Security, Medicare, or take student loan interest deductions, your RMDs could complicate things. Withdrawals from an inherited IRA could boost your income to levels that increase how much of your Social Security benefit is taxable.
If your income rises above certain thresholds, you may also face higher Medicare premiums or lose eligibility for student loan interest deductions.
For example, if your combined income exceeds $34,000 as an individual filer, up to 85% of your Social Security benefits could become taxable. For Medicare Part B beneficiaries, higher incomes can trigger monthly premiums that range from $244.60 to $594.
And if your modified adjusted gross income (MAGI) exceeds $80,000 ($160,000 for joint filers), you’ll lose the $2,500 student loan interest deduction.
The Need for Careful Planning
With these new rules and the potential tax consequences, proper planning is essential. Working with a financial advisor or tax professional can help you optimize your withdrawals, avoid unnecessary taxes, and maximize the value of your inheritance.
Spreading your withdrawals evenly over the 10-year period is often the safest bet. For those in high-income brackets, the benefits of tax deferral are more limited, but even a slight reduction in tax burdens can make a big difference.
Planning for changes in income, future tax rates, and government benefits will be critical in making the most of your inherited IRA.
FAQs
What is the 10-year rule for inherited IRAs?
You must empty the IRA within 10 years of inheriting it unless you meet certain exemptions.
Are inherited Roth IRA withdrawals taxed?
No, withdrawals from an inherited Roth IRA are tax-free.
When do new IRS rules on inherited IRAs start?
The new rules apply to IRAs inherited after 2019, with enforcement beginning in 2024.
How are traditional IRA withdrawals taxed?
Withdrawals from traditional IRAs are taxed as ordinary income.
Can inherited IRA withdrawals affect Social Security or Medicare?
Yes, they can increase your taxable income and potentially raise your Medicare premiums or the taxability of your Social Security benefits.
