Inheriting an IRA? Suze Orman's Advice Will Save Thousands in Taxes
A recent IRS rule change says most people must withdraw the total balance of inherited IRAs within 10 years of receiving them. But this is actually good news, as it extends the previous mandate, giving you more time to harvest gains at minimum taxation.
However, you need to be mindful of how you do so, or you're just handing free money to Uncle Sam. Doing so erroneously could seriously impact how you should manage your inheritance, as financial expert Suze Orman said in a LinkedIn post.
Here are the important exceptions to the IRS' recent reconsiderations and what Orman says it could mean for your financial plan.
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How To Beat the 10-Year Rule for Inherited IRAs
The IRS changed its rules for inherited IRAs in 2019. Before then, you'd have to withdraw all of the money from an IRA you inherit within five years. The new rule gives you 10, doubling the length of time you have to set yourself up for success — and it can even be closer to 11, since it's 10 full years following the year of death.
However, there's a notable exception for spouses. A surviving spouse can treat their inherited IRA as their own. They can essentially put the account in their name and make withdrawals according to their standard retirement timeline.
There are also exceptions for young people and the disabled or chronically ill. If a child inherits an IRA, then 10 years pass and they're still not 18, they aren't subject to the rule. Disabled and chronically ill inheritors don't have withdrawal requirements, either.
Orman's Factors To Consider Before Withdrawing
Any time the IRS changes its rules for retirement accounts, it's worth considering how it could impact your long-term financial strategy. Orman shared four key takeaways she believes people should remember when deciding how to use an inherited IRA.
1. Withdrawals From Traditional IRAs Are Taxed as Ordinary Income
If you inherited a Roth IRA, you'll still need to follow the 10-year rule for withdrawals. But the money won't be taxed as income — just as it's not for non-inherited Roth IRAs.
Orman said that differs from a traditional IRA. Any money you withdraw from one will be counted as taxable income. If you withdraw enough, it could bump you into a higher tax bracket for the year.
2. You Can Make Withdrawals Any Time Within Your 10-Year Window
"There is no rule that says you must wait until year 10 to empty the account or you must take out equal percentages each year," Orman wrote.
You get to choose how you withdraw money from your inherited IRA, as long as you complete the process within 10 years.
This gives you flexibility to set a withdrawal schedule that matches your financial needs. Taking advantage of this may be the best way to pay less in taxes on your inherited retirement account.
For example, say you inherit a traditional IRA with $100,000 in it. Now imagine you're $11,000 in income away from the next federal tax bracket. Knowing this, you might decide to withdraw $10,000 annually for the next 10 years. Doing so could keep you out of a higher tax bracket while still following the IRS' rules.
Or it could make sense to withdraw everything you inherit at once. Maybe the IRA had millions in it. If so, withdrawing an amount every year could put you in a higher tax bracket every year. Taking all the money out at once may put you in the highest tax bracket — but for only one year.
3. Older Adults Should Be Careful
Orman also said that adults 60 and older must be especially careful about making withdrawals from an inherited IRA. That's because monthly Medicare premiums are based on income. The more you earn, the more you pay.
Older adults may want to contact a financial advisor before proceeding. One could help you come up with an optimized strategy for withdrawals. That way, you don't pay more than you need to for health insurance without running afoul of the IRS.
4. Estate-Based Inheritances May Still Have a 5-Year Rule
Orman closed by sharing the IRS' different rule for IRAs inherited through estates. Essentially, if the estate is the direct beneficiary that received the IRA and the deceased hadn't begun taking distributions, the account must be emptied within five years.
Tax rules for estates differ from the ones individuals follow in ways beyond the scope of this article. You may want to consult with a financial advisor if you inherited through an estate and need help finding your ideal tax strategy.
Three Withdrawal Strategies
Given all of this, there are three main approaches you can use when withdrawing money from an inherited IRA.
1. Withdraw Everything Now
First, you can withdraw everything in the account at once. Doing so would give you a high income for that year, which would probably place you in a higher tax bracket. You may have a huge tax bill, but it's not something you'd ever have to worry about again.
This option can be smart if you plan on retiring soon. You'll get the income spike out of the way now, before it can influence your Medicare costs. This can also make sense if you want to use the money for a major purchase, like a down payment on a home. You'll just have to eat the large tax bill to make it happen.
2. Make Equal Withdrawals Over Time
The second option is making equal withdrawals over the IRS' 10-year period. This approach can work when you're trying to avoid higher tax brackets while making withdrawals.
3. Make Unequal Withdrawals
Finally, you can withdraw the funds from an inherited IRA unequally over the 10-year period. For example, you might withdraw $10,000 this year, but $30,000 next year.
One reason to do this would be timing when your biggest tax bills arrive. For example, maybe you're paying for your kid's college tuition and want to wait until they graduate to pay the majority of taxes on the inherited IRA.
You might also just want to make withdraws from the account as you need the money — without having to worry about all of the tax implications. That may not lead you to the optimal financial outcome, but it can help decrease stress, which is often worth paying for.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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