In 2020, changes to the rules surrounding individual retirement accounts were implemented, affecting the timeline for withdrawing money from inherited IRAs and potentially triggering tax consequences. The Secure Act of 2019 introduced a new 10-year window for so-called “non-eligible designated beneficiaries” to deplete an inherited IRA. Non-eligible designated beneficiaries include heirs who are not a spouse, minor child, disabled, or chronically ill individuals. This change has significant implications for those inheriting IRAs, particularly if the original account owner had already started their required minimum distributions (RMDs) before passing.
Impact on Heirs
The Internal Revenue Service (IRS) proposed mandatory yearly withdrawals for heirs in 2022, but subsequently waived penalties for missed RMDs due to confusion. However, these waived RMDs may create a tax quandary for certain heirs who still have to empty inherited accounts within 10 years. The shorter withdrawal window could lead to larger distributions and higher-than-expected income for those specific years, potentially affecting tax liability.
While there are significant tax implications to consider when withdrawing money from an inherited IRA, many beneficiaries may prioritize immediate access to the funds over long-term tax planning. According to individual retirement account expert and certified public accountant Ed Slott, most beneficiaries are focused on gaining access to the money rather than adhering to the 10-year rule. For many heirs, the funds from an inherited account are often earmarked for specific expenses, and the desire for immediate access is driven by urgent financial needs or obligations.
Changes in federal income tax brackets, as outlined in the Republicans’ 2017 tax overhaul, are set to expire after 2025. Without intervention from Congress, individual federal income tax brackets could revert to higher rates. This potential increase in tax rates underscores the importance of thoughtful tax planning when withdrawing funds from inherited IRAs, as heirs subject to the 10-year rule may need to consider making pretax withdrawals sooner to take advantage of lower tax brackets before 2025.
Certified financial planner Edward Jastrem emphasizes the need for a holistic approach to financial planning when considering IRA withdrawals. In addition to taking into account changes in tax laws and implications for inherited accounts, Jastrem highlights the importance of evaluating one-off events that could impact income, such as selling a business or a home. Understanding how these transactions can affect tax liabilities and retirement planning is crucial for making informed decisions about withdrawing money from inherited IRAs.
The importance of considering tax consequences when withdrawing money from an inherited IRA cannot be overstated. With changes to inheritance account regulations, potential shifts in tax brackets, and individual financial circumstances to consider, heirs must approach IRA withdrawals strategically. By seeking guidance from financial professionals and evaluating the broader implications of their financial decisions, heirs can navigate the complexities of inherited IRAs while minimizing tax liabilities and maximizing financial outcomes in the long run.