There are a couple of different sets of rules around inherited IRAs and you’re subject to the least flexible. While there are more options for a spouse or someone who’s chronically ill or disabled, a minor child, or someone not more than 10 years younger than the deceased IRA owner, you have just 10 years to withdraw the money.
Typically, heirs open their own IRA Beneficiary Distribution Account, which must be closed by Dec. 31 of the tenth year after the original IRA owner passed. But even with that deadline, you’ve still got a few choices to make – and rules to understand.
Someone in the 32% tax bracket is earning between $191,950 and $243,725 in taxable income if they’re single, so withdrawing the entire $450,000 now will push you solidly past the 35% tax bracket and into 37% bracket beyond an adjusted gross income of $609,350. While your exact liability you would pay depend on your income and other factors, you can expect your withdrawals to be taxed completely at the highest two tiers.
If you’re married and filing jointly, the 37% bracket comes into play when your taxable income is more than $731,200 or more. Being at the 32% tax bracket now, this means that this strategy is less advantageous than someone who is filing single. Based on the disproportionate income thresholds, a higher proportion of the withdrawals will be subject to the 37% tax rate.
Pros:
You take the tax hit now and can invest the remaining roughly $300,000 in any way you choose.
If you put the money in long-term investments, you can take the lower long-term capital gains tax rate, which ranges from 20% to 0%, depending on your income, which lowers the effective tax rate on the money in the long run. Based on your income now, you’re likely to face a 15% long-term tax rate.
Cons:
Right off the bat, you’d be sending an additional money to the IRS. You also sacrifice 10 years of potential tax-deferred growth within the IRA.
You can force yourself into a higher tax bracket.
On the other end of the spectrum, you can opt to draw your payments out over the full length of time allowed, or find somewhere in between the two. Consider matching with a financial advisor for free to discuss the best option for you.
The longer approach means spreading your withdrawals out to keep your tax bracket and tax liabilities down. While any growth of your account will be tax-deferred in the meantime, those gains will also be taxed at your marginal income tax rate when you do eventually withdraw them.
Pros:
For example, let’s say you’re single and have taxable income of $200,000 for 2024, and that the IRA value drops by 50% before the end of the year, reducing the balance to $225,000. You could withdraw $43,725 at the 32% tax rate, then reinvest that money before the market bounces back. That effectively doubles your withdrawal for the year from one-tenth of the balance to one-fifth, but keeps you in the lower tax bracket. The cash you withdrew can grow at the lower long-term gains rate, also lowering your effective tax rate over the long term.
Cons:
Growth on principal will be taxed at your marginal income tax rate, rather than the favorable capital gains rate, when you do eventually withdraw them.
If you otherwise see income growth, you may be pushed into higher tax brackets in the future anyway.
A financial advisor can help you understand the considerations that matter in your situation.
The “best” withdrawal strategy could change drastically from year to year, depending on what happens with tax laws and tax rates, as well as your other financial and life changes, such as:
Tax laws change: An increase in tax rates and changes in tax rules could help or hurt your withdrawal strategy, especially since you’re facing that 10-year deadline for taking all the money out. Remember that significant changes to tax rules have taken place in just the past several years, making unlikely that you can go an entire decade without your tax situation changing.
RMDs: Depending on a handful of factors, required minimum distributions, or RMDs, might come into play if you don’t withdraw the money all at once. Consider speaking with a financial advisor about the nuances of RMD rules.
Your finances change: If a financial disaster hits, you may need that IRA money sooner than later, although you’ll likely be in a lower tax bracket. Another possibility is that you’re able to defer some income in one year, lowering your tax rate and making a big withdrawal a good move. On the other hand, if your income increases significantly, your tax hit is likely to be bigger on your future IRA withdrawals.
As with so many personal finance questions, there’s no one “best” answer that works for everyone. Depending on your other financial factors, your age, your health, your goals, you lifestyle, possible changes in tax laws and other elements, each individual needs to calculate what works best for their situation.
A knowledgeable financial advisor can help you decide how to structure and coordinate these payments over the span of your retirement.
Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you.
Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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