Why you need an inheritance financial advisor if you’re inheriting an IRA
Why you need an inheritance financial advisor if you’re inheriting an IRA
Recent legislation shifted the game for anyone inheriting from an inherited IRA.
Learn when you NEED a professional in your corner and keep reading to get the expert help you need to avoid getting tripped up by taxes, penalties, or timelines when managing an inherited IRA..
Posted on August 28, 2024 by Katherine Fox.
Why you need an inheritance financial advisor if you’re inheriting an IRA
It feels impossible to know what to do after inheriting an IRA.
You’ve received a life-changing amount of money, but you’re deep in the weeds navigating the complexities of taxes, required distributions, and building an investment portfolio.
On top of that, you may be grieving, dealing with family strife, and trying to navigate your way forward after a loved one’s death.
You’re not alone.
Some inheritors have the time, interest, and expertise necessary to manage a multi-million dollar inheritance from an IRA on their own.
Some don’t.
Wherever you fall, keep reading for everything you need to know about finding your path forward after inheriting an inherited IRA.
I’m an inheritor myself and I’ve spent the better part of the last decade as an inheritance financial advisor, helping other inheritors manage their investments and their financial lives.
I’ve got ALL the information and tips you need to make a plan and evaluate if a financial advisor is right for you after inheriting an inherited IRA.
Most people don’t have any idea what to do when they inherit a large IRA.
You may have considered looking for a financial advisor to help, but you’re stuck with more questions than answers:
What do I need to know about inherited IRAs?
What are the new rules for inherited IRA distributions?
What taxes will I pay after inheriting an inherited IRA?
How much should I withdraw from my inherited IRA every year?
How should I integrate an inherited IRA into my overall financial plan?
Luckily, you ended up here.
Keep reading for the 5 ESSENTIAL things you need to know after inheriting an IRA, and how a financial advisor for inheritance can help you navigate your path forward.
I’m Katherine. I’m a CFP® and a financial advisor for inheritance.
I’m here to help you through this journey, whatever your needs are.
If you’re trying to get up to speed, check out the 20 Terms Inheritors Need to Know or How to Talk to Your Parents About Their End-of-Life or Estate Plan.
And if you’re deep in the weeds and don’t know what to do next, schedule a FREE consultation to see how I can help you build a plan to understand, manage, and grow your inherited wealth.
1. lWhat do I need to know about inherited IRAs?
The first thing you need to understand is why inherited IRAs are so complex.
There are five key reasons:
1. Different Rules for Different Beneficiaries: The rules governing inherited IRAs vary depending on your relationship to the original account owner and whether you're an eligible or a non-eligible beneficiary.
2. Changing Legislation: The SECURE Act of 2019 dramatically altered the landscape for inherited IRAs, eliminating the "stretch IRA" option for many non-spouse beneficiaries and significantly increasing the tax burden on non-eligible IRA beneficiaries.
3. Tax Implications: Distributions from inherited IRAs are generally taxable as ordinary income, which can significantly increase your annual tax bill.
4. Required Minimum Distributions (RMDs) and the 10-year rule: Inherited IRA beneficiaries may be required to take RMDs and are also required to empty the inherited IRA within 10 years.
5. Potential Penalties: Failure to follow IRS distribution rules for inherited IRAs can result in huge penalties, sometimes as high as 25% of the amount that should have been withdrawn.
The complexities of inherited IRAs mean that many inheritors prefer to work with an inheritance wealth management firm to ensure they build a plan to comply with all regulations and minimize the tax impacts of their inherited IRA.
5 ESSENTIAL things you need to know after inheriting an IRA
Keep reading to get educated and ensure you’re making the best long-term decisions when evaluating how to manage an inherited IRA.
2. What are the new rules for inherited IRA distributions?
The rules about how much and when beneficiaries need to withdraw funds are inheriting an IRA vary based on the age of the person who died, beneficiaries’ relationship to the person who died, and personal details about the beneficiaries.
These rules are complicated and understanding options, how much to withdraw, and when you need to withdraw, is more than many inherited IRA beneficiaries can handle. A financial advisor for inheritance can help you navigate this confusing landscape and build a withdrawal plan that satisfies your legal obligations, minimizes the taxes you pay on inherited IRA withdrawals, and helps you move toward your long-term goals.
Note: all of the below information is ONLY relevant for people who inherited IRAs after January 1, 2020.
Before January 1, 2020 a different set of rules applied that allowed more freedom for inherited IRA beneficiaries.
There are two classes of inherited IRA beneficiaries:
Eligible designated beneficiaries
Four groups of people fall into the “eligible designated beneficiary” category:
Spouse of the original depositor
Minor child of the original depositor
Disabled or chronically ill individuals
An individual that is not more than 10 years younger than the original depositor
Eligible designated beneficiaries have several options when inheriting an IRA:
Spousal beneficiaries may roll a spouse’s inherited IRA into their IRA, move a spouse’s IRA into an inherited IRA, and take required minimum distributions based on their life expectancy.
Other eligible beneficiaries may roll an IRA into an inherited IRA account and stretch distributions out over their lifetime - taking Required Minimum Distributions based on their life expectancy.
If eligible beneficiaries choose not to stretch out their IRA distributions, they will be required to fully empty the inherited IRA account within 10 years after the original depositor’s death.
Non-eligible designated beneficiaries
Non-eligible designated beneficiaries who don’t fit into the above categories.
Non-eligible designated beneficiaries only have one option when inheriting an IRA.
They must fully empty the account within 10 years after the original depositor’s date of death.
If the original depositor was already taking RMDs before they died, beneficiaries will also be responsible for taking a required minimum distribution every year.
3. What taxes will I pay after inheriting an inherited IRA?
There are no specific estate or inheritance taxes that are levied specifically on inherited IRAs.
Inherited IRAs may be taxed at the estate level, under Federal or state estate taxes, or at the beneficiary level as a state inheritance tax.
The primary concern of inherited IRA beneficiaries is income taxes.
For traditional pre-tax inherited IRAs, every dollar that comes out of the account is treated as taxable income.
This income is fully taxable at both the federal and state level.
If you inherit a small IRA and have a relatively low income, this may not be a problem for you.
However, if you are a high earner in a state with a high income tax, distributions from an inherited IRA may reduce your total inheritance by almost 40%!
Consider the following example:
Charlie and Bill are a married couple in California.
Together, they make $650,000/year.
Bill inherits a $5 million IRA when his mom dies.
To space out his distributions and minimize his total impact, he withdraws ~$600,000 from the IRA every year.
Of this $600,000 withdrawal, roughly $230,000 or almost 40% will be handed over to the federal government and California to pay taxes.
Working with an inheritance wealth management firm that provides tax planning is a critical need for many inheritors who inherit large IRAs and want to build a plan to minimize their tax exposure over the 10-year drawdown period.
“Most inheritors are best served by taking annual withdrawals over the 10-year withdrawal period. The goal of this withdrawal schedule should be to minimize taxes by avoiding a large withdrawal in any given year.”
4. How much should I withdraw from my inherited IRA every year?
How much you need to withdraw from your inherited IRA every year depends on your situation.
Most inheritors are best served by taking annual withdrawals over the 10-year withdrawal period. The goal of this withdrawal schedule should be to minimize taxes by avoiding a large withdrawal in any given year.
As a financial advisor for inheritance, I recommend dividing the account by the number of years left in the withdrawal period. In year 0, you would withdraw your account balance /10, in year 1 your account balance / 9, et cetera.
This usually works for the first five years, after which the withdrawal strategy may need to be adjusted based on investment returns.
Inheritors with more complex situations may benefit from working with an inheritance wealth management firm to help build a tax-efficient withdrawal plan customized for their specific goals.
Some inheritors may, for example:
Expect their income will increase significantly during the 10-year drawdown period and prefer to front-load distributions to reduce their overall tax exposure.
Use an inherited IRA as a down payment for a house and pull the majority of the account out in a given year.
Wait for withdrawals because they know they will have a few years of lower income during the 10-year drawdown period and want to bunch distributions in those years to reduce their overall tax exposure.
5. How should I integrate an inherited IRA into my overall financial plan?
An inherited IRA shouldn't be viewed in isolation.
It’s one piece of your overall financial puzzle and should be integrated into a full analysis of your broader goals and financial plan.
An inheritance financial advisor can help you build a plan that takes into account:
Your retirement time horizon
Your current and future goals
Your income needs
Your risk tolerance and investment goals
Your estate planning objectives
Your charitable giving intentions
Together, you can answer the questions:
How much should I withdraw each year from my inherited IRA?
How can I minimize taxes due on my inherited IRA?
How should I invest my inherited IRA?
How does this inherited IRA change my retirement timeline?
How does my inherited IRA connect with the other pieces of my financial picture?
By looking at your comprehensive financial picture, an advisor can help you make decisions that optimize your overall financial health, including what to do after inheriting an inherited IRA.
Let’s take the next step together
Understanding how to manage an inherited IRA is not easy. Inheritors can encounter a wide variety of different situations requiring knowledge and finesse to manage. If you need more help, you can download The 20 Inheritance Terms You Need to Know, or reach out to Katherine Fox, CFP® and CAP®, a fiduciary, fee-only financial planner to learn how Sunnybranch can help you build a plan to manage, grow, and protect your inherited investments.
