Most inherited IRAs are comprised of pre-tax money. When you take a withdrawal, you also have to pay taxes. This may not be an issue if the IRA is relatively small. But what if the retirement account is $100k, $200k or $500k+? A simple strategy for limiting the tax hit is spreading the tax hit out over multiple tax years. If timed correctly, a sizeable amount of money can be withdrawn within 13 months while spreading the tax liability across three tax years. This can result in major tax savings.

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Ted Erhart, CFP®
Financial Planner
Anoka, Minnesota
www.norrislakeretirement.com

Disclaimer: Since we don’t know your specific situation, none of this information should be construed as tax, legal, financial, insurance, financial advice, or other advice and may be outdated or inaccurate. It is your responsibility to verify all information yourself. This content is prepared for entertainment purposes only. If you need advice, please contact a qualified CPA, attorney, insurance agent, financial advisor, or the appropriate professional for the subject you would like help with. Ted Erhart cannot be held liable for any use or misuse of this content….(read more)

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INHERITED IRA Strategy: How to Limit Taxes on Big Withdrawals

When it comes to managing an Inherited Individual retirement account (IRA), one must be vigilant in understanding the tax implications associated with large withdrawals. Inheriting an IRA can be a substantial financial opportunity, but without proper planning, it can also result in significant tax burdens. With the right strategies, however, it is possible to limit taxes on big withdrawals and maximize the benefits of an Inherited IRA.

1. Stretch IRA Strategy:
The Stretch IRA strategy allows beneficiaries to extend the distributions over their lifetime, thereby reducing the tax impact. By taking required minimum distributions (RMDs) based on their life expectancy, rather than withdrawing the entire amount, beneficiaries can benefit from longer tax-deferred growth and potentially lower tax brackets. This strategy can effectively reduce the immediate tax liability associated with a big withdrawal.

2. Lump Sum Distribution:
While it might be tempting to withdraw the entire amount from an Inherited IRA all at once, this can lead to a substantial tax hit. Depending on the amount withdrawn, it could even push the beneficiary into a higher tax bracket. However, in certain situations, a lump sum distribution may make sense. For instance, if the beneficiary is in a low tax bracket or has immediate financial needs, they may consider taking the lump sum and paying the taxes upfront to avoid higher rates in the future.

3. Conversion to a Roth IRA:
Converting an Inherited IRA to a Roth IRA can be a smart move in terms of tax planning. While it might require paying taxes on the converted amount upfront, a Roth IRA provides tax-free growth and tax-free withdrawals in the future. By converting smaller amounts each year, beneficiaries can effectively manage their tax liability and potentially avoid a significant tax hit that would come with a large withdrawal later on.

4. Charitable Contributions:
Qualified charitable distributions (QCDs) can be an advantageous way to limit taxes on large withdrawals from an Inherited IRA. If the beneficiary intends to make charitable donations, rather than taking a distribution and donating, they can direct the distribution directly to a qualified charity. This technique can satisfy the IRA’s RMD requirements while excluding the donated amount from taxable income.

5. Strategic Withdrawals:
Planning how and when to withdraw funds from an Inherited IRA can also play a significant role in tax management. By carefully assessing their annual income, beneficiaries can strategically withdraw money during years when they are in lower tax brackets. This approach allows for more tax-efficient withdrawals, ultimately reducing the overall tax liability.

It is crucial for beneficiaries of Inherited IRAs to consult with a financial advisor or tax professional to navigate the complex tax rules that apply to such accounts. These professionals can help devise a personalized strategy that aligns with their financial goals while minimizing the tax impact of large withdrawals from an Inherited IRA.