How Do I Avoid Paying Taxes on an Inherited IRA?
An inherited IRA is a type of retirement account you may inherit when someone dies, with its own set of regulations that differ from traditional or Roth IRAs.
First and foremost, consult a financial professional regarding your specific circumstances. They can advise on how best to utilize inheritance funds while minimizing taxes.
Take a lump-sum distribution.
IRS rules regarding inheritance accounts can be complex and confusing. In certain instances, it may make sense to spread your distributions out over 10 years rather than taking a lump sum immediately and thus potentially shifting into a higher tax bracket. Surviving spouses typically enjoy greater flexibility than non-spouse beneficiaries who must take required minimum distributions according to their life expectancies.
But a recent ruling from the IRS may alter this strategy for non-spouse heirs. Now, these accounts must be empty by Dec 31 of the year following their original owner’s death – potentially leaving non-spouse heirs facing an enormous income tax bill.
Spousal beneficiaries might benefit from placing funds in an inherited IRA by taking ownership and designating yourself as the account holder. This approach can allow the account to grow over decades while limiting annual withdrawals; 10 year forward averaging may also significantly lower tax liabilities.
Utilize charitable planning.
There are various strategies you can employ to avoid paying taxes on an inherited IRA, depending on its type and how distributions are made. One possible strategy involves taking lump-sum distributions during years when your income tax bracket is lower – this can lower overall tax payments significantly.
One way to reduce tax liability while supporting your favorite causes is to name charities as beneficiaries of an IRA and make qualified charitable distributions from it. This strategy provides a great opportunity to do both.
Use an inherited IRA to establish a donor-advised fund and recommend grants from it over time to charities of your choosing. Before taking any steps, consult your financial advisor and CPA before taking any actions – this is particularly important if inheriting it from parents as they will likely understand any tax implications and can take steps to safeguard you against costly penalties.
Transfer the account to a new account.
Withdrawing all or a part of an IRA at once forfeits any potential for tax-deferred growth and may trigger immediate income taxes; depending on its size, this could incur an enormous IRS bill. Instead, consider transferring it into an inherited IRA in your name; funds can stay put while giving you up to 10 years to withdraw them while adhering to IRS minimum distribution guidelines.
Spouses may assume ownership and postpone their RMD until age 70; non-spouse beneficiaries, on the other hand, must begin taking withdrawals over their life expectancies so this option may not suit everyone. If this option appeals to you, seek advice from a financial firm offering inherited IRAs who can assist in filling out transfer paperwork and explaining potential tax savings strategies that might work better with this account (it’s often called “stretch IRA” due to this feature).
Get a second opinion.
IRS website provides ample guidance regarding distributions from an IRA; however, it can be challenging to ascertain which course of action best meets the needs of each situation. A second opinion can assist with making the right choice.
Rules regarding inheritance IRA withdrawals depend on both beneficiary status and account type. For instance, spouse beneficiaries can delay RMDs, while non-spouse beneficiaries must complete withdrawal within 10 years.
Beneficiaries can sidestep the 10% early withdrawal penalty by treating their inherited IRA as their own and taking distributions according to either their life expectancy or that of the deceased account owner’s. This strategy can also preserve tax benefits like tax-deferred or tax-free growth. Another strategy would be transferring the assets directly into an existing IRA, which may help achieve both charitable goals as well as reaping all the tax advantages available through such accounts – though any decisions regarding such transfers should be carefully thought through prior to implementation.
Categorised in: Blog