Tax Planning Strategies for Inherited IRAs
Starting in 2025, certain beneficiaries of inherited individual retirement accounts (IRAs) will be required to take annual distributions or face a penalty. However, some non-spousal beneficiaries may want to consider taking distributions sooner, depending on their situation, even if annual withdrawals aren’t required.
Understanding the 10-Year Rule
Before the Secure Act of 2019, heirs could “stretch” inherited IRA withdrawals over their lifetime, reducing yearly taxes. But since 2020, certain accounts inherited are subject to the “10-year rule,” requiring IRAs to be empty by the 10th year following the original account owner’s death. This rule applies to heirs who are not a spouse, minor child, disabled, chronically ill, or certain trusts.
Required Minimum Distributions (RMDs) in 2025
After years of waived penalties, the IRS confirmed in July that certain heirs will need to begin yearly RMDs from inherited accounts starting in 2025. This applies if the original account owner had reached their RMD age before death. Missing yearly RMDs or not taking enough can result in a 25% penalty on the amount you should have withdrawn.
Spreading Withdrawals Evenly vs. Strategic Distributions
Spreading withdrawals evenly over the 10 years can reduce taxes for most heirs. However, certified financial planner Judson Meinhart suggests considering “strategic distributions.” This involves understanding your current marginal tax rate and how it could change over the 10-year window.
Timing Withdrawals for Optimal Tax Benefits
Making withdrawals during lower-tax years, such as years of unemployment or early retirement before receiving Social Security payments, can be beneficial. However, boosting adjusted gross income can trigger other consequences, such as eligibility for college financial aid, income-driven student loan payments, or Medicare Part B and Part D premiums for retirees.
Creating a Tax Planning Strategy
It’s essential to understand how these rules impact your distribution strategy. By considering your individual situation and tax implications, you can create a plan to maximize the benefits of your inherited IRA. Consult with a financial advisor to determine the best approach for your unique circumstances.
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