Mike Palmer in Kiplinger: Inherited an IRA? Don't Fall Into the 10-Year Tax Trap

If you inherit an IRA or 401k from someone other than your spouse, you need to start planning immediately, because the tax clock is ticking! New tax rules enacted a few years ago have now been clarified by the IRS. The upshot? If you don't carefully plan you could have a tax landmine waiting for you within a few years.  

The Death of the Stretch IRA

Ark Royal's founder Mike Palmer, CFP®, writes a monthly column for Kiplinger and shares his perspective and expertise in this article (Inherited an IRA? Don't Fall Into the 10-Year Tax Trap). Mike reviews different strategies inheritors of IRAs can use depending on their individual circumstances including:

• Taking distributions evenly over the 10-year window
• Taking just required minimum distributions (RMDs) in the early years and taking larger distributions in retirement (if applicable)
• Why Roth IRAs have different rule RMD rules
• The tax savings with proper planning can be in the tens of thousands of dollars

The Dangers of Doing It Yourself

Most custodians don't provide yearly RMD information on inherited IRAs, which means many do-it-yourselfers could be flying blind. We've seen examples of consumers who used the wrong RMD table to calculate their RMD - an error that could result in a 25% IRS penalty.

What Is the 10-Year Rule?

For most non-spouse beneficiaries (like adult children), the law now requires that the entire inherited IRA be emptied by the end of the 10th year following the original owner’s death.

While that sounds straightforward, the IRS recently cleared up a major point of confusion: if the original owner had already started taking Required Minimum Distributions (RMDs) before they passed, you cannot wait until year 10 to take the money. You must take annual RMDs in years 1 through 9, and then empty the remainder in year 10.

The Tax Trap of Waiting

The biggest mistake many heirs make is waiting until the very last minute to withdraw the bulk of the account.

Imagine you inherit a $450,000 IRA. If you leave it alone for 10 years and it grows to $600,000, a single lump-sum withdrawal in the final year could push you into the highest tax bracket (currently 37%). You could lose nearly half of that inheritance to federal and state taxes in one fell swoop.

Exceptions to the 10-Year Rule

Not everyone is subject to the strict 10-year limit. "Eligible Designated Beneficiaries" can still potentially use the old life-expectancy stretch rules. These include:

• Surviving spouses.
• Minor children of the account owner (until they reach age 21).
• Disabled or chronically ill individuals.
• Beneficiaries who are not more than 10 years younger than the deceased.

At Ark Royal, we've helped hundreds of people successfully navigate retirement. Give us a call if you'd like to schedule a complimentary consultation!