Your inherited individual retirement account could trigger a ‘tax bomb,’ advisor says. How to avoid it
If you’ve inherited a pre-tax individual retirement account since 2020, you could face a sizable tax bill without proper planning, experts say.
Previously, heirs could take inherited IRA withdrawals over their lifetime, known as the “stretch IRA.”
However, the Secure Act of 2019 enacted the “10-year rule,” which requires certain heirs, including adult children, to deplete inherited IRAs by the 10th year after the original account owner’s death.
But waiting until the 10th year to make IRA withdrawals “could mean sitting on a tax bomb,” said certified financial planner Ben Smith, founder of Cove Financial Planning in Milwaukee.
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Pre-tax IRA withdrawals incur regular income taxes. The 10-year rule can mean higher yearly taxes for certain heirs, particularly for higher earners with bigger IRA balances.
Shortening the 10-year withdrawal window can compound the issue, experts say.
Larger withdrawals can significantly boost your adjusted gross income, which can have other consequences, such as higher capital gains tax rates or phaseouts for other tax benefits, Smith said.
For example, Smith has seen people lose eligibility for the electric vehicle tax credit, worth up to $7,500, by taking a large inherited IRA withdrawal in a single year.