Advertisement
IRAs

How to Minimize Taxes When You Inherit an IRA

One key: Take minimum distributions each year based on your life expectancy.

I am the beneficiary of my mother’s IRA. What options do I have for withdrawing the money when she passes away?

You have several options when you inherit an IRA, and the one you choose can have a big impact on how much you pay in taxes. The rules are different for spouses than for nonspouse beneficiaries. They’re also different for traditional IRAs than they are for Roths, which generally are not taxed when left to heirs.

Advertisement - Article continues below

If you inherit a traditional IRA, you can cash out the account at any age -- even before you reach age 59½ -- without having to pay a 10% early-withdrawal penalty. But you will have to pay taxes on the money in the account (except for any nondeductible contributions).

If nonspouse beneficiaries don’t start taking withdrawals by December 31 of the year after the IRA owner dies, then they must withdraw all of the money in the account within five years. Otherwise, you must take minimum distributions from the account based on your own life expectancy, starting by December 31 of the year after the original owner’s death. These required withdrawals are similar to the required minimum distributions (RMDs) for IRA holders over age 70½, but they use a different life expectancy table. The withdrawals will still be taxable (except for any nondeductible contributions), but the rest of the money can continue to grow tax-deferred in the account.

Advertisement - Article continues below
Advertisement
Advertisement - Article continues below

Spouses who inherit a traditional IRA have extra choices. They can roll the money into their own IRA, so they don’t have to start taking required minimum distributions (based on their life expectancy) until they reach age 70½. But they’d have to pay a 10% early-withdrawal penalty for money they take from the account before age 59½.

If the original IRA owner was 70½ or older and had already started taking RMDs before he or she died, then the beneficiary can continue to take annual withdrawals based on the original owner’s life expectancy schedule or take withdrawals based on his or her own life expectancy.

The rules are different for Roth IRAs, which can usually be inherited tax-free. But you can’t keep the money in the account forever. Original Roth IRA owners don’t have to take required minimum distributions, but nonspouse heirs have to take annual distributions from the account based on their life expectancy, starting the year after the original IRA owner dies (spouses have the option of rolling a Roth into their own account). Or you can withdraw all of the money in the account within five years. Either way, you generally won’t have to pay taxes on the withdrawals.

For more information about these rules and the IRS life-expectancy tables for required withdrawals, see IRS Publication 590, “Individual Retirement Arrangements.”

Advertisement
Advertisement

Most Popular

11 Dividend-Paying Stocks You Should Think Twice About
dividend stocks

11 Dividend-Paying Stocks You Should Think Twice About

Dividend-paying stocks often can be a store of safety, but 2020 has been difficult on income equities. These 11 picks look like shaky plays despite th…
September 21, 2020
Medicare Basics: 11 Things You Need to Know
Medicare

Medicare Basics: 11 Things You Need to Know

There's Medicare Part A, Part B, Part D, medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare --…
September 16, 2020
Where You Should Invest Now
investing

Where You Should Invest Now

Kiplinger.com senior investing editor Kyle Woodley joins our Your Money's Worth podcast to answer investor questions about tech stocks, the election a…
September 22, 2020

Recommended

How To Buy a Roth IRA When You Make Too Much To Qualify For One
Roth IRAs

How To Buy a Roth IRA When You Make Too Much To Qualify For One

With their tax-free growth and tax-free withdrawals, Roth IRAs are a great deal — if you qualify. If you don’t, well, there’s still a way to get into …
September 23, 2020
The Annuity With a Tax-Planning Twist
Financial Planning

The Annuity With a Tax-Planning Twist

A qualified life annuity contract helps retirees with guaranteed payments to last their entire lives.
September 21, 2020
Child Tax Credit Would Go Up Under Biden Proposal
Politics

Child Tax Credit Would Go Up Under Biden Proposal

Some families would see their tax credit jump from $2,000 to $3,600 per child under Joe Biden's plan. But there are a couple of important catches.
September 18, 2020
Election 2020: Joe Biden's Tax Plans
taxes

Election 2020: Joe Biden's Tax Plans

With the economy in trouble, tax policy takes on added importance in the 2020 presidential election. So, let's take a look at what Joe Biden has said …
September 18, 2020