How Much Tax You Pay on an Inherited IRA: 4 Rules That Matter
Two beneficiaries can inherit similar balances and end up with very different tax bills.
For some people, inheriting an IRA can feel like a financial windfall. But before you decide what to do with the money, there's a key question: How much will you actually keep after taxes?
The answer depends on more than the IRA balance. Where you live, your relationship to the person who left you the account, the type of IRA you inherited, and when you take the money out also matter.
That's why two people can inherit IRAs with the same balance and potentially face different tax bills. One beneficiary may have flexibility over when to take distributions, while another might have to empty the account within a set period. An heir in a state that taxes IRA distributions could owe more than someone in a state that doesn't.
Here's more to know about key factors that affect your inherited IRA tax burden.
Inherited IRA tax rules
To understand how much of an inherited IRA you'll keep, it helps to start with some basic tax rules.
Generally, inheriting an IRA isn't itself a taxable event for federal income tax purposes. Instead, taxes depend on the type of IRA you inherit and how you take distributions.
State tax rules can also affect how much you owe.
Things to keep in mind:
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- Distributions from an inherited traditional IRA are typically taxed as ordinary income on your return, at applicable federal marginal tax rates.
- Qualified distributions from an inherited Roth IRA are generally tax-free.
- A 10% early withdrawal penalty often applies to IRA owners who withdraw money before age 59½, but it generally doesn’t apply to distributions from an inherited IRA, regardless of your age.
- Timing is also important. Many beneficiaries must meet distribution deadlines, and missing a required withdrawal can trigger a 25% federal IRS penalty on the amount you failed to take.
But those are federal rules. State tax laws can differ — sometimes significantly.
Some states tax IRA distributions based on where you live, while a handful impose inheritance taxes based on where the deceased person lived.
Together, these rules can affect how much tax you might owe on an inherited IRA and when you need to withdraw the money. Here are four key questions to consider.
1. Where do you live and where did the account owner live?
When it comes to state taxes, two questions can affect how much of an inherited traditional IRA you keep.
1. Does your state tax IRA withdrawals as income?
2. Did the person who left you the account live in a state that imposes an inheritance tax?
Five states currently impose inheritance taxes: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. (Whether you owe inheritance tax generally depends on where the deceased person lived or owned taxable property and your relationship to them.)
Estate taxes are different. The estate generally pays them before distributing assets to heirs. Twelve states and the District of Columbia impose estate taxes. Maryland is the only state that imposes both estate and inheritance taxes.
Note: At the federal level, taxable distributions from an inherited traditional IRA generally count as ordinary income.
Type of tax |
Whose rules generally apply? |
|---|---|
Federal income tax on IRA withdrawals |
Federal rules, regardless of where either person lived |
State income tax on IRA withdrawals |
Generally, the beneficiary's state of residence in states that tax such income |
State inheritance tax |
Generally, the deceased person's state of residence in states with inheritance tax |
State estate tax |
Generally, the deceased person's state of residence in states with estate tax |
| Row 4 - Cell 0 | Row 4 - Cell 1 |
An example: Suppose you live in Florida and inherit a traditional IRA from someone who lived in Pennsylvania.
Florida, a state without an individual income tax, generally won't tax your IRA withdrawals as income. Pennsylvania also generally exempts IRA distributions paid to a designated beneficiary.
But...Pennsylvania may impose its inheritance tax on the IRA balance if the deceased owner was age 59½ or older at death (or was disabled at death regardless of age).
When Pennsylvania inheritance tax applies, the rate depends on your relationship to the deceased:
- Surviving spouse: 0%
- Direct descendants and other lineal heirs: 4.5%
- Siblings: 12%
- Most other beneficiaries, including friends: 15%
Yes, it can get confusing and this is just one simplified example.
The takeaway: When inheriting a traditional IRA, consider both the state income tax on withdrawals and whether inheritance or estate taxes may apply. Rules differ by state, and the type of tax can affect how much you ultimately keep.
2. What was your relationship to the person who left you the IRA?
The rules can vary depending on whether you inherited the account from a spouse, parent, other relative, or someone unrelated.
A surviving spouse generally has options that most other beneficiaries don't. Depending on the circumstances, a spouse may be able to treat the inherited IRA as their own or keep it as an inherited account. Those choices affect the distribution rules and can influence when withdrawals are required.
An adult child who inherits a parent's IRA, however, generally can't simply treat the account as their own. Instead, the beneficiary rules apply.
- For many individual non-spouse beneficiaries who inherit from someone who died after 2019, the account generally must be emptied by December 31 of the tenth year following the year of the original owner's death.
- Exceptions generally apply to Eligible Designated Beneficiaries (EDBs), including surviving spouses, the owner's minor children (until they reach the age of majority, at which point the 10-year rule kicks in), disabled or chronically ill individuals, and beneficiaries not more than ten years younger than the deceased owner.
- The specific requirements depend on your beneficiary category and the circumstances of the owner's death.
It's also important to know that the 10-year rule for inherited IRAs doesn't mean every beneficiary can wait until the final year to withdraw the money. Depending on the rules that apply, you may need to take annual required minimum distributions (RMDs).
Additionally, your relationship to the deceased doesn't automatically set the federal income tax rate on a withdrawal. Rather, that relationship status determines which distribution rules apply and how much flexibility you have over timing.
The takeaway: Know your beneficiary category before you plan any withdrawals. Your relationship to the deceased may determine when you must take the money out, even though your taxable income generally determines the federal income tax rate you pay.
3. What kind of IRA did you inherit?
Not all inherited IRAs are taxed the same way. One key distinction is whether the account is a traditional IRA or a Roth IRA.
- With a traditional IRA, contributions may have received favorable tax treatment when the original owner made them.
- As a result, taxable withdrawals generally count as ordinary income for the beneficiary in the year the money is distributed.
- If you inherit a traditional IRA and take a large distribution, the added income could push some of your earnings into a higher federal tax bracket.
Note: If the original owner made nondeductible contributions, part of the account may represent after-tax money. In that case, the entire distribution may not be taxable.
A Roth IRA can produce a different result. Qualified Roth IRA distributions to beneficiaries are generally tax-free, provided the requirements are met. The five-year rule is relevant when determining whether a distribution qualifies for tax-free treatment.
But tax-free doesn't necessarily mean you can leave an inherited Roth IRA untouched indefinitely. Beneficiaries generally remain subject to distribution deadlines, although the specifics depend on the beneficiary and other circumstances.
The difference can be notable in some cases. Someone who inherits a traditional IRA may need to plan for income tax on withdrawals, while someone who inherits a Roth IRA may receive qualified distributions without owing federal income tax.
The takeaway: Find out whether the account is traditional or Roth before you estimate your tax bill. The account type you inherit can make a substantial difference in how withdrawals are taxed.
4. When do you take the money out?
Once you've sorted out your state residency, beneficiary status, and IRA type, another key question remains: When should you withdraw the money?
For many beneficiaries of traditional IRAs, timing can affect your tax bill.
For example, let's say you inherit a traditional IRA worth $300,000 and also earn a substantial salary. Taking the entire balance in one year could add a large amount of taxable income on top of your normal pay. Depending on your circumstances, some of that additional income could fall into a higher marginal federal income tax bracket.
Taking distributions over several years may help manage that. However, spreading withdrawals out isn't automatically the best strategy for everyone. You still have to comply with applicable deadlines and any annual required minimum distributions.
- For many non-spouse beneficiaries subject to the ten-year rule, the account must be fully distributed by the end of the tenth year following the original owner's death.
- Depending on when the owner died and whether required distributions had already begun, annual withdrawals may also be required during that period.
For example, if an IRA owner dies in 2026 and the beneficiary is subject to the standard ten-year rule, the account generally must be emptied by December 31, 2036. Other beneficiary categories may follow different rules.
A Roth IRA may offer a different planning opportunity because qualified withdrawals are generally tax-free, but distribution deadlines can still apply.
The key is to consider the inherited IRA alongside your other income, your expected financial needs, and the deadlines that govern the account. A withdrawal strategy that works for someone approaching retirement might not be ideal for a beneficiary in their peak earning years.
The takeaway: The amount you withdraw in a particular year can affect the income tax you ultimately owe. The challenge is balancing tax planning with the rules on how quickly you must empty the account.
Avoiding taxes on an inherited IRA: Bottom line
Inheriting an IRA doesn't necessarily mean you should take the money right away. And waiting as long as possible isn't always the best approach either.
Before you take a distribution, find out when you must empty the account and whether you have to take annual withdrawals. Then consider how a distribution would affect your taxable income in the year you receive it. Depending on your circumstances, coordinating withdrawals with your other income and expenses over several years may help mitigate the tax impact.
Also keep in mind that landing in a higher tax bracket doesn't mean all of your income is taxed at that higher rate. Federal income tax rates are marginal, so only the portion of your taxable income that falls within a higher bracket is taxed at that rate.
If the account balance is substantial, or you have questions about these or other key factors, consider consulting a tax professional before deciding. The goal is to make informed decisions that comply with the distribution rules and make sense for your finances over the entire period you'll be managing the inheritance.
Remember: This article is for general informational purposes and is not individualized tax or legal advice. Consult a qualified tax professional about your specific situation.
Related
- Inherited IRA Rules Every Beneficiary Should Know
- Why The IRS is Taking a Closer Look at Trusts
- Inheritance Tax vs Estate Tax: Who Actually Pays
- Are No-Income-Tax States Better to Live In?
