How Do I Avoid Paying Taxes on an Inherited IRA?

Inherited retirement accounts present unique challenges that can be difficult to navigate. Luckily, there are various methods available to you for avoiding tax on an inherited IRA.

Beneficiaries must first determine whether their account owner had reached their RBD. If so, annual distributions must take place. To reduce taxes further and help their families save more in taxes it may also be wise to convert to Roth.

Roll the assets into your own IRA

An IRA rollover can be an excellent way to avoid paying taxes on inheritance assets. To prevent running into trouble with IRS regulations, it’s advisable to seek advice from a financial professional with expertise in inheriting IRAs before initiating any transactions.

Although the government offers tax breaks to encourage retirement savings, when money is withdrawn it must also go back into government coffers in the form of required minimum distributions (RMDs) starting at age 72 for original account holders as well as beneficiaries inheriting an IRA.

Only spouse beneficiaries may stretch out RMDs over their lifetime; non-spouse beneficiaries typically have 10 years to withdraw the entire account balance and pay income tax on it. Therefore, it is wise to plan ahead by taking RMDs only when necessary – otherwise your withdrawal could force your taxable income into higher tax brackets.

Take a lump-sum distribution

Inherited IRAs differ in terms of tax regulations from accounts contributed to directly by account holders themselves, giving account owners many choices on how they should use these funds – the right option will vary depending on what kind of IRA was given and who gifted it.

In most cases, an inherited IRA must be distributed within 10 years after its original account owner passes away. Otherwise, any lump sum distribution would require income taxes be paid and may forgo opportunities for tax-deferred growth.

Traditional IRAs are comprised of both deductible and nondeductible contributions, so part of each distribution is taxable, and new account holders must distribute all their assets over 10 years or incur a 10% penalty. Beneficiaries have some flexibility when taking their required minimum distributions (RMDs); it may make sense for them to stretch them over their life expectancies as per circumstances.

Take RMDs over your life expectancy

Due to recent changes in law and interpretations by the IRS, it is crucial for beneficiaries of an inherited IRA to understand all of their options for reducing taxes on it. A financial professional can provide invaluable assistance.

If you inherit an IRA and you’re under required minimum distribution (RMD) age, withdrawals can be spread out over your life expectancy to lower tax payments each year. RMDs must start being taken by December 31 of the year following the original account holder’s death.

Be careful that you do not withdraw too much in one year, which could increase your taxable income and lead to an unexpectedly larger tax bill. A financial advisor can assist with determining an appropriate withdrawal amount; additionally they may arrange for your IRA custodian to automatically withhold this tax amount from each withdrawal each year – this saves time from making quarterly estimated tax payments while potentially mitigating underpayment penalties.

Transfer the assets to an alternate beneficiary

An inheritance from an IRA account can be both exciting and gratifying, but it’s crucial that you understand its options and requirements before beginning distributions. This is particularly relevant if your inheritance comes from an account held by someone other than your spouse as there may be separate rules which apply.

Spousal beneficiaries have the option to transfer any inherited assets into their own retirement accounts in order to defer taxes until withdrawing them in retirement, although if you take an early withdrawal before reaching 10 years, there will be a 10% penalty from the IRS.

Disclaiming assets is another option available to account owners and Eligible Designated Beneficiaries who wish to renounce annual required minimum distributions and pass them along. A financial professional can assist with helping determine which option best meets their needs.


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