How to Avoid Paying Taxes on an Inherited IRA
After an IRA owner passes, their beneficiaries have several choices regarding what happens with their account. It’s essential that all options be thoroughly explored and professional advice sought prior to making any definitive decisions about these assets.
Rolling inherited IRA funds into a beneficiary’s own retirement account may be the easiest solution; this offers several advantages. One benefit is postponing RMDs until age 70 1/2.
Roll it into your own IRA
As inheriting IRA assets is no simple process, there are ways to minimize taxes. Consulting a tax professional to understand all of the rules governing an inherited IRA may help minimize taxes; additionally it is wise to plan out when to withdraw large sums – large withdrawals in a single year may increase your taxable income and thus your marginal tax rate; “bracket topping” strategies may help ensure you pay only necessary amounts of taxes.
If you are the spouse of an account owner who has passed on, and inherit their IRAs tax-deferred investment accounts can be transferred into your own. This option can help maximize the benefits of inheritance while keeping taxes to a minimum – however you must take required minimum distributions (RMDs) within 10 years from December 31 of the year following his or her death, with specific tax consequences depending on what type of account it is.
Withdraw it as a lump-sum distribution
When inheriting an IRA, there are various considerations you’ll need to keep in mind. The first step should be making sure your beneficiary designations are current; though it might be uncomfortable, discussing this topic with family can prevent future heirs from making costly decisions that result in taxes.
Depending on your relationship to the original account owner, you have two options for rolling over their IRA: either you take withdrawals over 10 years or deplete it all by age 72 – though depletion requires taking required minimum distributions (RMDs) which could push them into higher tax brackets.
Alternative Strategies (ASPs) also provides another method of withdrawing an IRA: Lump sum distributions are best for individuals over the age of 59 1/2 who can handle taxes associated with such withdrawals.
Withdraw it over a period of 10 years
Except if they were near retirement age, original account owners typically needed to begin taking annual distributions (known as required minimum distributions or RMDs). Anyone inheriting their accounts must also abide by these regulations and withdrawals are taxed at regular income tax rates.
Beneficiaries can avoid paying taxes on all of their inheritance by depleting an IRA over 10 years, gradually withdrawing amounts based on current income levels and avoiding moving into higher tax brackets.
However, this option comes with several caveats. Beneficiaries should carefully monitor their annual taxable income to make sure that withdrawing enough doesn’t push them into another tax bracket and also note that this strategy won’t reduce the size of your estate for estate planning purposes – therefore consulting with a financial advisor would be wise before opting for this strategy.
Take it as a distribution
An inheritance of an IRA can be an unexpected financial boon, but there may also be tax repercussions. Before making decisions regarding an inherited IRA, always consult with a financial professional.
Government provides tax breaks for retirement savings accounts (IRAs), in order to encourage planning. But as soon as these IRAs have been used for non-spouse beneficiaries, income taxes could come due, potentially leaving a huge income tax bill behind.
To avoid taxes, an easy way to roll over an inherited IRA into your own account at another financial institution is requesting a trustee-to-trustee transfer between institutions that currently hold your account and your new custodian. By investing according to your goals and risk tolerance you’ll still have RMDs but won’t incur an early withdrawal penalty of 10% before age 59 1/2.