The Inherited IRA Time Bomb: 5 Things Every Beneficiary Needs to Do Before December 31
The clock starts ticking the moment you inherit an IRA, generally giving you 10 years to drain the account. Before year-end, make sure you're properly managing your withdrawals — and minimizing your taxes.
One of my clients, a single woman in her early 50s, inherited an IRA of $900,000. She earns about $200,000 a year before her bonus, which puts her firmly in the 24% federal tax bracket. She didn't need the money right away, and with 10 years to empty the account, there was no obvious rush.
But if she simply took out about $90,000 a year, most of every withdrawal would be taxed at 32% or 35%.
The 10-year rule isn't always as simple as it sounds, either. Depending on when the original owner died, you may have to take money out every year. And even if you follow the minimum requirements perfectly, waiting too long to take larger withdrawals could leave you with a much bigger tax bill toward the end of the 10-year period.
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Before December 31, there are five things every inherited IRA beneficiary should understand.
1. Make sure you're following the right rules
Not everyone who inherits an IRA follows the same schedule. Most adult children who inherit an IRA from a parent who died in 2020 or later fall under the 10-year rule. The inherited account generally has to be completely emptied by December 31 of the 10th year after the owner's death. So if a parent died in 2021, the inherited IRA would generally need to be emptied by December 31, 2031.
There are exceptions. Spouses have additional options, and different rules may apply to certain disabled or chronically ill beneficiaries, minor children of the account owner and beneficiaries who are close in age to the person who died.
You don't need to memorize every IRS category. You do need to know which one you fall into and the exact year your account has to be emptied.
2. Find out whether you need to withdraw money this year
For many inherited traditional IRAs, whether annual required minimum distributions (RMDs) are required depends on whether the original owner had already reached their required beginning date.
If the owner died after reaching that point, the beneficiary generally has to continue taking annual RMDs while also making sure the entire account is gone by the end of year 10. If the owner died before reaching that point, annual withdrawals generally aren't required during years one through nine, although the account still has to be emptied by the deadline.
The IRS provided temporary penalty relief for certain missed inherited IRA RMDs from 2021 through 2024, but that relief has ended. Missing a required distribution can now result in a 25% penalty on the amount that should have been withdrawn, which drops to 10% if the mistake is corrected in a timely manner.
Before year-end, make sure you know whether an RMD applies to you and whether the correct amount has already been taken. IRS Publication 590-B includes the life expectancy table used to calculate it.
3. Don't just think about this year's tax bill
Withdrawals from a traditional inherited IRA are generally taxable income, so the timing of those withdrawals matters.
Suppose you get toward the end of the 10-year period and still have $300,000 sitting in the account. If the deadline arrives, you may have no choice but to withdraw that entire balance on top of your salary or other retirement income, pushing a large portion of it into higher tax brackets.
Instead, look at the entire 10-year period. Compare what happens if you take only the required minimum each year, take roughly equal withdrawals, or intentionally take larger amounts during certain years. The goal shouldn't simply be to pay the least tax this year. It should be to manage the tax bill over the entire life of the inherited account.
4. Work the inheritance into your retirement plan
If you're still earning a high salary today but plan to retire in a few years, it may make sense to take smaller distributions while you're working and larger ones after your paycheck stops. But pensions, Social Security, withdrawals from your own retirement accounts, Medicare premiums and, if you retire before 65, health insurance costs all affect that calculation.
That's the approach we took with the client I mentioned earlier. For the next few years, she is taking only the minimum withdrawals while she is earning significant money.
Our plan is to have her retire early and liquidate the IRA over a three-year period. She will still land in a higher tax bracket in those years than the one she's in while working, but she will pay less in tax overall than if she simply took out 10% of the account each year.
That is the difference between simply following the 10-year rule and actually planning around it.
5. Look for lower-income years
Maybe you retire halfway through the year. Maybe you change jobs, work fewer hours or have a down year in your business. Those years can be an opportunity to take more from an inherited IRA while your other income is temporarily lower.
For example, imagine an additional $40,000 withdrawal would all fall into a 22% federal tax bracket this year but could fall into a 32% bracket later. Ignoring other tax considerations, that's the difference between $8,800 and $12,800 of federal income tax.
A low-income year shouldn't go to waste without at least running the numbers. Before December 31, look at your projected income, determine how much room you have in your current tax bracket and decide whether taking more than the minimum makes sense.
The inherited IRA rules can feel complicated, but the planning questions are fairly simple: When does this money have to come out, and when would it make the most sense for it to come out? Those answers aren't always the same.
Good planning can also begin years before an inheritance happens. If your children are likely to be in a higher tax bracket than you when they inherit your IRA, Roth conversions on your own accounts may be worth a hard look while you still have the ability to change the outcome.
Your loved one likely spent decades earning and saving that money. Taking the time to build a withdrawal strategy can help make sure more of that inheritance goes toward your family's goals instead of being dictated by a tax deadline.
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