Navigating the 10-Year Inherited IRA Window

Ken Hargreaves, CFP®, AIF®, AWMA®, CRPC®
There may come a time when you are the beneficiary of an IRA, whether from a spouse, family member, or other loved one. The rules surrounding Inherited IRAs are complex and full of exceptions and nuances. However, if you are a recent non-spouse beneficiary, you may be subject to the relatively new ten-year withdrawal window. This will be the subject of this article – what your options are, how your tax plan may be affected, and how a financial advisor can guide you through the decision-making process.

The Ten-Year Window

While the kinds of inherited IRAs are complicated, the actual ten-year rule is straightforward.

The IRA qualifies for the ten-year rule treatment if the following statements are true: 

  1. You are the non-spousal or non-eligible designated beneficiary. 
  2. The original owner hadn’t reached the Required Minimum Distribution age by the time of passing. 
  3. The original owner passed away on or after January 1st, 2020.  

Upon inheriting an IRA or 401(K) subject to the ten-year rule, you have ten years to remove all assets and funds from it – specifically by December 31st of the tenth year of the original owner’s passing.

In that timeframe, you can remove as many funds as you want whenever you like. You can wait a few years and take everything as a lump sum, slowly but steadily remove funds from it, or wait until the last moment and remove everything before December 31st of the tenth year – it’s up to you. The correct strategy, however, depends on your financial situation.

Scenario 1: Take a Lump Sum Withdrawal

Why You Would Do It:

You might opt for a lump sum if you need immediate liquidity for significant expenses, like buying a home, paying for college, an investment opportunity, or having emergency savings. You also don’t want to risk the market falling and reducing the value of the IRA or feel taxes will go up in the future. 

Pros:

  • Immediate access to funds for timely large-scale investments or expenses.

Cons:

  • Eliminates the possibility for continued tax-deferred growth within the Inherited IRA.
  • May lead to a considerable tax bill, reducing the overall inheritance.

Scenario 2: Evenly Spread Out Until Year 10

Why You Would Do It:

This approach could be beneficial if you’re looking to manage annual taxable income effectively and stay within a lower tax bracket while taking advantage of the potential growth of the investments in the IRA. 

Pros:

  • Tax efficiency by spreading the taxable distributions over several years.
  • Keeps the IRA’s funds growing on a tax-deferred basis, potentially increasing the overall benefit.
  • Provides a regular income stream, which can be helpful for budgeting and financial planning.

Cons:

  • Requires disciplined planning and regular review of distribution strategies to optimize for changing tax laws and personal circumstances.
  • Could result in paying more taxes over time if tax rates increase.

Scenario 3: Strategic Withdrawals Over Ten Years

Why You Would Do It:

You may choose to withdraw significant sums at strategic intervals if you have fluctuating income or anticipate specific periods when additional funds will be needed. This approach allows for flexibility in managing cash flow while considering the tax implications of each withdrawal.

Pros:

  • Aligns IRA distributions with your financial needs at different stages, allowing for better cash flow management.
  • Offers tax planning opportunities by taking larger withdrawals during years when you expect to be in a lower tax bracket.
  • Retains the IRA’s growth potential by only withdrawing what is needed – when it’s needed.

Cons:

  • Requires sophisticated planning and a keen understanding of your tax situation year by year.
  • Could lead to higher taxes in years when other income is also high or if tax rates increase across the board.

Scenario 4: Withdraw All Funds Right Before Deadline

Why You Would Do It:

You might wait until just before the deadline if you believe your tax situation will be more favorable in the future or if you want to maximize the growth potential of the investments within the IRA for as long as possible.

Pros:

  • Maximizes the period of tax-deferred growth within the IRA.
  • May coincide with a time when you fall into a lower tax bracket, such as retirement, reducing the tax impact.

Cons:

  • Risky if tax rates rise significantly or if your income level changes unexpectedly, leading to a more considerable tax burden.
  • Puts pressure on making a financial decision in a short time frame, which could lead to rushed judgments.
  • If the market is down when you withdraw, you could end up with a lower total sum than if you had taken smaller distributions over time.

A Note on the Inherited Roth IRA

It’s crucial to note that for Roth IRAs, distributions are typically tax-free, but they must meet the five-year holding period requirement. If the Roth IRA hasn’t been open for at least five years before the original owner’s death, earnings may be subject to taxes, though the 10% early withdrawal penalty does not apply.

How a Financial Advisor Can Help

Receiving a significant sum of money, especially during the trying times of a loved one’s passing, is an emotionally charged event. A fiduciary financial advisor can help guide you through the decision-making process with your best interests in mind, relieving you of the stress that comes with such situations.

Crafting a Holistic Financial Plan

A financial advisor can evaluate your entire financial landscape, including other income streams, investments, and financial goals. They’ll consider factors like your current tax bracket, projected future income, retirement plans, and other personal financial tar. Depending on those goals and your tax situation, they’ll then help you determine an optimized withdrawal strategy.
If you decide to reinvest your funds, an advisor can choose the best investment assets that align with your plan while keeping in mind your risk profile and make adjustments as necessary.

In Conclusion

The guidance here specifically addresses non-spouse beneficiaries with ten-year window accounts. Spouses or beneficiaries with different IRA rules will need tailored advice. However, if you’ve inherited an IRA subject to the ten-year rule, it’s crucial to formulate a strategy that aligns with your financial goals and tax situation.
A fiduciary financial advisor can help you navigate the process. With rules and goals constantly changing and markets going up and down, it’s good to have an expert by your side so you can focus on living your life instead of stressing about how to manage your inheritance.
Our aim is to help you make the best decisions for your financial future. If you’d like a consultation on your Inherited IRA, feel free to schedule an appointment by clicking the button below.
Disclosures

Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s portfolio. All investment strategies have the potential for profit or loss. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author/presenter as of the date of publication and are subject to change and do not constitute personalized investment advice.

A professional advisor should be consulted before implementing any investment strategy. WealthGen Advisors does not represent, warranty, or imply that the services or methods of analysis employed by the Firm can or will predict future results, successfully identify market tops or bottoms, or insulate clients from losses due to market corrections or declines. Investments are subject to market risks and potential loss of principal invested, and all investment strategies likewise have the potential for profit or loss. Past performance is no guarantee of future results.

Please note: While we strive to provide accurate and helpful information, we are not Certified Public Accountants (CPAs). The information in this article is intended for informational and educational purposes only and should not be interpreted as tax advice. It is crucial to consult with a CPA or tax professional to discuss you

Author

  • Ken Hargreaves, CFP®, AIF®, AWMA®, CRPC®

    A Florida native, and full-time Sarasota resident, Ken founded WealthGen Advisors, LLC after spending more than fourteen years in the financial advisory industry. Ken holds multiple industry designations, as well as a master's degree in Financial Planning. Prior to founding WealthGen Advisors, Ken spent almost a decade in New York and then Texas as Vice President at The Capital Group, a $2T global investment manager serving institutional clients and pension funds.

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