The New Hidden Tax Trap of Inherited IRAs
We’ve seen how inheriting an IRA can be a life changing! But I’ve also seen how it could be handled not ideally from a tax perspective and you could lose more than you should to Uncle Sam.
It's important to be aware of the potential tax implications, especially if you inherited the account after 2020. Let me break it down for you in a way that's hopefully easy to understand as there are many new rules regarding these.
Imagine you've inherited a traditional pre-tax IRA from someone other than your spouse. Over the past few years, the IRS has been giving people a nice break by waiving the requirement to take a Required Minimum Distribution (RMD) each year. At first glance, this might seem like a good thing and could be depending on your situation.
You can let the money sit and grow, right? Not so fast though! While you won't be forced to take out a specific amount each year, you still need to empty that account by the end of the 10th year from the original owner's death. It's like the IRS is saying, "Sure, you can delay taking the money out, but you'll have to deal with it eventually.
Let's fast forward to year 10. Let's say you hypothetically inherited $300,000, and you've let it sit and grow. Now, it's worth a lot more than it was 10 years ago (assume whatever growth rate you’d like with an investment calculator. For compliance reason’s we’ll skip that). This sounds great, right?! Yes, but there is a common pitfall that happens when it’s not planned well and the IRS loves it because it means more money in their pocket.
Consider a common example… Let’s say you’re working or even retired with no other income… Forces to cash out that inherited IRA could push you into the higher federal tax brackets in that year. And that's not all. You could also be hit with additional taxes since you have such a large income in one particular year now!
But wait, there's more especially if you’re near Medicare age! Remember those Medicare premiums? Well, get ready for a shock because they could skyrocket from $174.70 to a whopping $594 per person for 1-2 years. That's an extra $10,000 out of your pocket for the same coverage. Ouch! *(source below)
We don’t want to pay more in taxes than we legally have to. Tax strategizing and planning involved with your investments are crucial!
So, what's the solution to navigating all the complexities of retirement planning? The answer is to get ahead of the game and project out your income, taxes, Medicare costs, Social Security benefits, investment growth, and other key factors years into the future. I know, I know - it sounds like a lot of work. And you're right, it does involve research, studying and making educated assumptions about the future. But here's the thing - taking the time to map out these details now can pay off big time down the road.
Understanding the new inherited IRA rules is crucial for beneficiaries to properly manage and distribute inherited retirement accounts while minimizing potential tax implications.
If you’re looking for help, our team specializes in helping clients navigate financial situations like this. We'll work with you to understand your unique circumstances and develop a plan that mitigates your tax burden and strives to maximize your inheritance. Remember, the key is to be proactive ahead of time! Don't let the IRS pull the wool over your eyes.
Source: https://www.medicareinteractive.org/get-answers/medicare-health-coverage-options/original-medicare-costs/part-b-costs-for-those-with-higher-incomes