These inherited IRA mistakes could reduce your windfall, advisors say
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While many investors welcome the windfall, the rules surrounding inherited individual retirement accounts are complex and mistakes can be costly.
Since 2020, some inherited accounts “10 year rule,” and heirs must discharge the balance by the 10th year after the death of the original account holder.
Additionally, some non-spousal beneficiaries, especially adult children, must begin taking required minimum distributions, or RMDs, within the 10-year period in 2025 or face a hefty IRS penalty.
Inherited IRA planning is important during a “major wealth transfer.” more than 100 trillion dollars It is expected to change hands by 2048, according to a December report from Cerulli Associates.
Here are three of the biggest inherited IRA mistakes and how to avoid them, according to financial advisors.
1. Not knowing IRS rules
For non-spousal heirs ” [inherited IRA] The rules can get complicated quickly, and knowing your options is critical,” said certified financial planner Brett Koeppel, founder of Eudaimonia Wealth in Buffalo, New York.
“10 year rule” and The new RMD requirement for 2025 applies to most non-spousal beneficiaries, such as adult children, if they reach RMD age before the death of the original IRA owner.
If you fail to take rollover IRA RMDs for 2025, you may be subject to a 25% IRS penalty on the amount you must withdraw. However, you can reduce this fee to 10% by paying the correct amount within two years and applying. Form 5329. In some cases, the IRS may waive the penalty entirely.
2. Not planning for ‘major taxes’
If you inherit a pre-tax IRA, you can expect to pay regular income taxes on withdrawals, which may require tax planning during the 10-year deduction, experts say.
Some heirs aim to receive only their RMD for the first nine years and a lump sum in year 10. But that could mean “significant taxes in the final year of the distribution,” said CFP John Nowak, founder of Alo Financial Planning in Mount Prospect, Illinois. He is also a certified public accountant.
Instead, experts say you should make multi-year tax projections to decide the best withdrawal amounts for each year. For example, it may make sense to accelerate distributions in temporarily low-income years.
3. Maintaining the same investments
Another common mistake is not replacing inherited IRA assets, according to Jamie Bosse, CFP, senior advisor at CGN Advisors in Manhattan, Kansas.
Ideally, investments should fit your risk tolerance, goals, and timeline. “This is your money now and it needs to be allocated according to your needs,” he said.
But Alo Financial Planning’s Nowak said you need to weigh your tax liability, annual RMD and income needs when choosing investments.
For example, keep Certificates of deposit in your IRA that have a maturity date beyond your RMD window can be “difficult or costly to distribute,” he said.
