Inheriting an IRA
You inherited a $5M IRA. The IRS gave you ten years. Here's the plan.
A $5 million inherited IRA can significantly change your family’s financial future. But it also comes with a deadline and potentially significant tax consequences.
For many beneficiaries, the question is not whether the money has to come out. It is when to take distributions and how to manage the resulting taxes.
Watch the video below for an overview, then continue reading for the key planning considerations.
Key Takeaways
- Many non spouse beneficiaries must fully distribute an inherited IRA within 10 years.
- Traditional inherited IRA withdrawals are generally taxed as ordinary income.
- Taking equal withdrawals every year may not be the most tax efficient strategy.
- Lower income years can create opportunities to take larger distributions.
- Waiting until the final years can reduce your flexibility and potentially increase the tax impact.
- Your investment strategy should be coordinated with your expected withdrawal timeline.
Understanding the 10 Year Rule
For decades, many IRA beneficiaries could stretch distributions over their own life expectancy, potentially allowing inherited retirement assets to remain tax deferred for decades.
The SECURE Act significantly changed those rules.
Today, many non-spouse beneficiaries, including adult children inheriting an IRA from a parent, generally must fully distribute the account by the end of the tenth year following the original owner’s death.
There are important exceptions. Surviving spouses have additional options, and certain minor children, disabled individuals, chronically ill beneficiaries, and other eligible beneficiaries may be subject to different rules.
There is another important consideration: depending on the original account owner’s circumstances, annual required distributions may also apply during years one through nine.
Before deciding how much to withdraw, you first need to understand which rules apply to the account you inherited.
Why a $5 Million IRA Changes the Tax Equation
The same 10 year deadline may apply whether you inherit $200,000 or $5 million. What changes dramatically is the potential tax impact.
Distributions from a traditional inherited IRA are generally taxed as ordinary income. They do not receive preferential capital gains treatment simply because the account was inherited.
This can be particularly important for executives, business owners, physicians, and other high earning professionals who may already be in elevated tax brackets.
Adding hundreds of thousands of dollars of IRA distributions on top of salary, bonuses, business income, or stock compensation could push additional income into higher marginal tax brackets.
That is why simply dividing the account into 10 equal withdrawals may not be the best strategy.
Think in Tax Years, Not Equal Withdrawals
Instead of asking:
“How much should I withdraw every year?”
Consider asking:
“Which years may be the most efficient years to recognize this income?”
Your income is unlikely to remain exactly the same for the next decade.
Retirement, a career transition, or a temporary decline in business income could create an opportunity to take a larger distribution during a lower income year.
The opposite can also be true.
If you expect to sell a business, receive a significant bonus, exercise stock options, or recognize substantial income in a particular year, taking a large inherited IRA distribution during that same year could compound the tax impact.
A thoughtful strategy considers your expected income and major financial events across the entire 10 year period.
Why Waiting Can Be Costly
One of the most tempting approaches is doing nothing.
Leaving the account invested may initially seem logical. The assets remain tax deferred, the account can continue growing, and the deadline seems far away.
But every year that passes removes another year of flexibility.
Someone who begins planning early may have close to a decade to coordinate distributions. Someone who waits until the final few years may be forced to recognize much larger amounts of taxable income over a shorter period.
The goal is not necessarily to withdraw aggressively from day one. It is to evaluate the opportunity each year rather than allowing the deadline to dictate the strategy later.
Traditional and Roth Inherited IRAs Are Different
Traditional and Roth inherited IRAs may both be subject to a 10 year distribution period, but their tax treatment can be very different.
Traditional inherited IRA distributions generally create taxable ordinary income.
Qualified Roth IRA distributions are generally tax free.
Because of this difference, the appropriate distribution strategy for an inherited Roth IRA may look very different from the strategy for a traditional inherited IRA.
The two accounts should not automatically be treated the same.
Coordinate Your Investments With Your Withdrawal Plan
Tax planning is only one part of the strategy.
Your investment portfolio should also reflect when you expect to withdraw the money.
Assets you expect to distribute within the next year or two may need to be invested differently from assets that could remain in the account for another seven or eight years.
Coordinating the portfolio with the expected withdrawal schedule can help reduce the risk of having to sell investments at an unfavorable time simply because a distribution is needed.
Common Inherited IRA Mistakes
Waiting too long to develop a plan
Starting earlier generally provides more flexibility across the 10 year window.
Assuming there are no annual distribution requirements
Depending on the circumstances, annual required distributions may apply before year ten.
Treating traditional and Roth IRAs the same
Their tax treatment is different, and their distribution strategies may need to be different as well.
Ignoring the tax bill
Large traditional IRA distributions can create significant tax obligations. Withholding and estimated tax payments should be considered as part of the strategy.
Taking the same amount every year
Your income and financial circumstances will change. Your withdrawal strategy should have the flexibility to change with them.
The Bottom Line
A significant inherited IRA creates both a deadline and an opportunity.
The 10 year rule means many beneficiaries cannot leave inherited retirement assets untouched indefinitely. But that window also provides an opportunity to coordinate withdrawals with income, taxes, investments, retirement, and other major financial decisions.
The greatest flexibility often exists at the beginning of the 10 year period, before years of potential planning opportunities have passed.
Have You Inherited a Significant IRA?
Every situation is different. Your income, retirement timeline, investments, account type, tax situation, and broader financial goals can all influence the appropriate strategy.
At Tidecrest Wealth Management, we help families coordinate these decisions as part of a broader wealth management plan.
If you would like help evaluating an inherited IRA and developing a distribution strategy around your circumstances, contact our team to start a conversation.
This material is provided for educational purposes only and should not be considered individualized tax, legal, or investment advice. Tax laws and inherited IRA rules are complex and subject to change. Consult your tax, legal, and financial professionals regarding your specific circumstances.