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Here are key things to know before tapping inherited IRAs

Jacob Wackerhausen | iStock/360 | Getty Images

If you inherited an individual retirement account since 2020, you may have a shorter window to withdraw the money, which may result in tax consequences. But there are a few things to consider before emptying a legacy account, experts say.

Under the Secure Act of 2019, so-called “non-eligible designated beneficiaries” have a 10-year window to deplete an inherited IRA. Ineligible designated beneficiaries are heirs who are not a spouse, minor child, disabled or chronically ill. Some trusts may also fall into this category.

In 2022, the IRS proposed mandatory annual withdrawals for heirs if the original account owner had already started their required minimum distributions, or RMDs. But the agency has since waived penalties for RMDs missed by heirs, amid confusion.

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These RMD waivers could create a tax problem for some heirs who still have to empty inherited accounts within 10 years, experts say. The shorter window could mean larger distributions and higher revenues than expected for those years.

However, “most beneficiaries don’t even care about the 10-year rule. They just want the money,” said Ed Slott, an individual retirement account expert and CPA.

Most beneficiaries don’t even care about the 10-year rule. They just want the money.

Ed Slott

Expert in individual retirement accounts

Heirs tend to reserve their inheritance for certain expenses and “the money comes out for the funeral,” he explained.

In fact, nearly 40% of Americans expecting an inheritance will use that money to pay off debt, according to a 2023 New York Life survey.

Tax changes are ‘one of many moving parts’

Provisions of the 2017 tax overhaul, signed by Republicans, are set to expire after 2025 and, without changes from Congress, federal individual income tax brackets could be higher.

Before 2018, the federal individual brackets were 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. But five of these brackets are temporarily lower until 2025: 10%, 12%, 22%, 24%, 32%, 35% and 37%.

Lower brackets through next year could encourage some heirs subject to the 10-year rule to take pre-tax withdrawals earlier.

But the expected tax law changes are just “one element of many,” according to certified financial planner Edward Jastrem, director of planning at Heritage Financial Services in Westwood, Massachusetts.

“To some extent, I would lean toward other aspects of a client’s situation being potentially more important,” he said.

Before withdrawing money from an inherited account, you’ll need to consider one-time situations like selling a business or home, which could temporarily increase your income. You also need to weigh your expected retirement date and when to start withdrawing RMDs from your own retirement accounts, Jastrem said.

“It’s an overview of each client’s plan,” he said.

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