If you’ve recently inherited an IRA, you need to be aware of several important tax considerations, especially if the IRA came from someone other than your spouse.

Because while the original account owner could wait until they reached retirement age to start taking distributions from the account, you might need to start taking withdrawals right away—and perhaps even accelerate your distributions. In this article, we’ll explain why.

The 10-Year Rule for Inherited IRAs

Let’s start with the basics. When you inherit an IRA from someone who isn’t your spouse, the IRS generally requires you to deplete the account within ten years. That means you must withdraw all the funds in that time frame.

You can’t wait until the ten-year window is up, either. The IRS recently issued final rules confirming that most beneficiaries must take annual required minimum distributions (RMDs) over ten years, with the account fully depleted by the end of the tenth year.

Exceptions to the 10-Year Rule

As with most tax rules, there are a few exceptions. The following beneficiaries are exempt from the 10-year rule:

• Surviving spouses
• Minor children (under age 21)
• Disabled or chronically ill people
• Beneficiaries not more than ten years younger than the deceased

If you’re required to take RMDs but haven’t been doing so, don’t panic. The IRS recognized there was some confusion around the rules, so they implemented a grace period. From 2021 through 2024, affected beneficiaries don’t have to take RMDs.

Why Bigger Withdrawals Might Be a Smart Move

Here’s where you can benefit from some tax planning strategy. Currently, federal income tax rates are relatively low thanks to the Tax Cuts and Jobs Act of 2017. But unless Congress passes new tax reform legislation, these rates are set to increase after 2025. The highest marginal tax bracket will jump from 37% to 39.6%, and taxpayers will likely pay higher rates in every bracket.

So, how does this affect you and your inherited IRA?

You can take advantage of the current lower tax rates by taking larger withdrawals now. Yes, you’ll pay taxes on those distributions, but at a lower rate than you might in the future.

Of course, try as we might, we can’t predict the future. There’s always a chance that Congress could extend the lower tax brackets or make other changes to the tax code that impact your decision. Still, based on what we know now, it’s worth discussing with your tax advisor.

Options for Inherited IRAs

To help you consider your options, let’s look at a hypothetical example. Say you inherited a Traditional IRA from a family member who had not yet reached the age where they were required to take RMDs.

You have two options for dealing with the account:

1. Open an inherited IRA and take RMDs over ten years. You’ll need to transfer the assets into an Inherited IRA in your name and start taking RMDs throughout the ten years. The RMD amount each year will vary based on your age and the value of the inherited account. The distributions count as taxable income, but you won’t have to pay a 10% early withdrawal penalty even if you’re under age 59½. You must deplete the account by the end of ten years.
2. Lump sum distribution. You can take the money out all at once rather than spreading the distributions out over ten years. Again the money is taxable, but you won’t owe an early withdrawal penalty. Just keep in mind that this strategy could push you into a higher tax bracket depending on the distribution amount and your current income level.

Until recently, the IRS allowed non-spousal IRA beneficiaries a third option. They could open an inherited IRA account in their name and spread distributions over their life expectancy based on their age. This “stretch IRA” strategy is no longer an option unless the beneficiary is a spouse, minor child, disabled or chronically ill individual, or not more than ten years younger than the deceased.

Inheriting a Roth IRA

Usually, Roth IRA owners don’t have to take RMDs. However, that rule flies out the window for beneficiaries who inherit Roth IRAs.

If you inherit a Roth IRA, you will need to take RMDs just as you would for an inherited Traditional IRA. However, the benefit of inheriting a Roth account is that withdrawals are tax-free as long as the account is at least five years old at the time of the withdrawal.

Options for Spousal Beneficiaries

Surviving spouses have more options when dealing with an inherited IRA. They can:

1. Keep the account where it is and delay the start of RMDs until they turn 73
2. Roll over the account into their own IRA and stretch RMDs over their own life expectancy
3. Take distributions following the 10-year rule
4. Take a lump sum distribution

Plan Smart, Act Smart

Taking larger distributions now could provide some flexibility for your financial planning. It might allow you to reinvest the funds in different ways, pay off high-interest debts, or even fund new business ventures. The key here is to stay proactive and think ahead.

Of course, everyone’s financial situation is unique, and it’s essential to have a personalized plan. Reach out to NewWay Accounting if you need help making the best decision for your specific circumstances. Remember, it’s not just about meeting the IRS requirements—it’s about optimizing your financial health for the long term.

Take control, plan ahead, and don’t let those future tax changes catch you off guard. After all, managing your inherited IRA wisely today could mean a more financially secure tomorrow.