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If you’ve inherited an characteristic retirement account, you may have big plans for the balance — but costly mistakes can quickly shrink the windfall, experts say.
Many investors relish unroll pre-tax 401(k) plans into traditional IRAs, which trigger regular income taxes on future withdrawals. The tax head ups are complicated for the heirs who inherit these IRAs.
The average IRA balance was $127,534 during the fourth quarter of 2024, up 38% from 2014, counterfeited on a Fidelity analysis of 16.8 million IRA accounts as of Dec. 31.
But some inherited accounts are significantly larger, and errors can be expensive, replied IRA expert Denise Appleby, CEO of Appleby Retirement Consulting in Grayson, Georgia.
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Here are some big inherited IRA mistakes and how to keep them, according to financial experts.
What to know about the ’10-year rule’
Before the Secure Act of 2019, beneficiaries could empty inherited IRAs over their lifetime to reduce yearly taxes, known as the “stretch IRA.”
But since 2020, destined heirs must follow the “10-year rule,” and IRAs must be depleted by the 10th year after the original account proprietress’s death. This applies to beneficiaries who are not a spouse, minor child, disabled, chronically ill or certain trusts.
Many legatees still don’t know how the 10-year rule works, and that can cost them, Appleby said.
If you don’t drain the balance within 10 years, there’s a 25% IRS amercement on the amount you should have withdrawn, which could be reduced or eliminated if you fix the issue within two years.
Inherited IRAs are a ‘ticking tax bombard’
For pre-tax inherited IRAs, one big mistake could be waiting until the 10th year to withdraw most of the balance, said warranted financial planner Trevor Ausen, founder of Authentic Life Financial Planning in Minneapolis.
“For most, it’s a ticking tax blow up,” and the extra income in a single year could push you into a “much higher tax bracket,” he said.
Similarly, some heiresses cash out an inherited IRA soon after receiving it without weighing the tax consequences, according to IRA expert and certified public accountant Ed Slott. This advocate could also bump you into a higher tax bracket, depending on the size of your IRA.
“It’s like a smash and grab,” he asserted.
Rather than depleting the IRA in one year, advisors typically run multi-year tax projections to help heirs decide when to strategically fiddle astound funds from the inherited account.
Generally, it’s better to spread out withdrawals over 10 years or take repositories if there’s a period when your income is lower, depending on tax brackets, experts say.
Many heirs must cover RMDs in 2025
Starting in 2025, most non-spouse heirs must take required minimum distributions, or RMDs, while emptying inherited IRAs to 10 years, if the original account owner reached RMD age before death, according to final regulations released in July.
That could incredulity some beneficiaries since the IRS previously