HUNTSVILLE, Ala. (WAF)— The rules for inheriting retirement accounts such as IRAs from a non-spouse can be complicated and costly if not handled properly. Understanding these regulations is critical to minimizing tax burden.
Financial expert Jay McGowan of The Welch Group shares strategies to potentially save taxes when inheriting these accounts.
Rules for Non-Spouses: What You Need to Know
The IRS rules for inheriting IRAs from someone other than a spouse are complex and can vary based on individual circumstances. However, a general guideline is that non-spouse beneficiaries must withdraw all funds from the inherited IRA within ten years. This means you can’t just let the money grow indefinitely as you could face penalties if you don’t stick to the withdrawal timeline.
Although the rules seem simple, they have many nuances. For example, the timing of withdrawals and how they align with your income level are critical in determining the taxes you owe. McGowan emphasizes that understanding the implications of these withdrawals, such as the impact on ordinary income and tax deferral opportunities, is critical to creating an effective strategy.
Important considerations
When planning how to handle an inherited IRA, beneficiaries should consider several factors:
- Ordinary income: Withdrawals from inherited IRAs are generally treated as ordinary income, meaning they are taxed at your current income tax rate. If you don’t manage this carefully, it could put you in a higher tax bracket.
- Tax Deferral vs. Minimization: While the goal is often to defer taxes for as long as possible, it is also essential to minimize the overall tax impact. Finding the right balance is important for maximizing the value of the inherited account.
- Account value: The size of the inherited IRA can influence your strategy. Larger accounts may require a different approach than smaller ones due to their impact on your overall tax situation.
- Personal Income: Your current and expected future income levels should factor into your withdrawal strategy. If you anticipate a year of lower income, it may be wise to take larger distributions during that period to minimize your tax liability.
Planning strategies to save on taxes
To effectively navigate these rules, McGowan offers several planning strategies:
- Plan for income changes: If you know your income will fluctuate over the next ten years, plan your withdrawals around these changes. By taking larger distributions in lower-income years, you can reduce your overall tax bill.
- Increase 401(k) or IRA contributions: To offset the tax impact of inherited IRA withdrawals, consider increasing contributions to your retirement accounts. This can help reduce your taxable income and balance the added income from the inherited IRA.
- Bunch Charitable Giving: If you are a charity, bundling charitable contributions into one year when you make a large distribution can maximize tax benefits. By donating more in a high-income year, you may be able to significantly reduce your taxable income.
McGowan recommends consulting with a financial advisor who can tailor a strategy to your specific situation and help you navigate the complexities of inherited IRA regulations.
For more information about The Welch Group, click here.
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