Smart Strategies for Managing Taxes When You Inherit an IRA
If you have recently inherited an IRA, you may be facing a set of financial decisions you have never encountered before. The rules can be confusing, the tax implications significant, and the timing of withdrawals critical to keeping more of the money your loved one intended for you. We wrote about the three main types of beneficiaries and their withdrawal rules in a previous blog here. Consider reviewing that topic first, then come back here to find out how non-eligible designated beneficiaries can plan for taxes.
Non-eligible designated beneficiaries, those who don’t have an exception as an “eligible designated beneficiary,” must fully distribute the IRA within 10 years following the death of the original account owner. For many beneficiaries, this compressed time frame can create tax headaches if not planned carefully. The following insights outline key strategies to help you navigate this process and reduce unnecessary tax burdens.
Understanding the Non-Eligible Designated Beneficiary Category
The most common non-eligible designated beneficiaries are adult children who inherit an IRA from a parent. Of note minor children of the original IRA owner are considered eligible beneficiaries, until they reach the age of majority. Then they become non-eligible and must also abide by the 10-year rule. The requirement to empty the IRA by the end of the 10th year following the IRA owners death applies whether the inherited account is a traditional pre-tax IRA or a Roth IRA.
While this article cannot address every possible scenario, the strategies discussed here are ones that often apply to many beneficiaries and are approaches financial planners like myself use regularly with clients. It is also important to coordinate with a CPA or tax professional who can review the specifics of your tax situation and work in tandem with your financial planner to ensure no detail is overlooked.
First, Know Which Type of IRA You Inherited
An inherited IRA will generally be one of two types:
- Roth IRA – Distributions are typically tax-free as long as certain conditions are met. There are usually no required annual distributions before the 10-year deadline.
- Traditional (Pre-Tax) IRA – All distributions are taxed as ordinary income in the year they are taken. If the original IRA owner was already taking required distributions before their death, the beneficiary will likely have to continue annual distributions AND deplete the IRA before the 10-year deadline.
The planning approach will vary significantly depending on which one you have.
Roth IRA: The Easier Case
If you inherit a Roth IRA, the best approach in most situations is to leave the money invested for as long as possible within the 10-year window. Because growth inside a Roth IRA is tax-free, delaying withdrawals can increase the amount you ultimately receive if all goes well with the investments.
While you must empty the account by the end of the 10th year, there are generally no annual withdrawal requirements before then. That means you can let the investments grow untouched and then take a lump sum in year 10, tax-free.
Just please, do not forget about the account entirely. Ten years is a long time. Mark the distribution deadline on your calendar and set a reminder. Missing the deadline can trigger IRS penalties, which would be an entirely avoidable loss.
Traditional IRA: Where Tax Planning Matters Most
Inheriting a pre-tax traditional IRA presents a bigger challenge. Since all distributions are taxed as ordinary income to the beneficiary, the amount and timing of withdrawals can push you into higher tax brackets.
To understand why, think about the U.S. progressive tax system. Income is grouped into brackets before it is taxed, and each bracket is subject to a specific rate. Think of your income tax like filling buckets, each with a specific tax rate, and when each bucket gets full, the income starts filling the next bucket. For 2025, the brackets range from 10 percent at the lowest tier up to 37 percent at the highest.
If you take a large distribution from an inherited IRA in a single year — for example, waiting until year 10 and withdrawing $500,000 at once — you may fill the lower tax buckets quickly and force most of that income into the highest brackets. Someone in the 22% bracket could fill up 22%, 24%, 32%, and most of 35% in this scenario. This can cost tens of thousands of dollars more in taxes compared to being a little more careful about planning your distributions.
Three Core Strategies to Reduce Taxes on Inherited IRA Distributions
1. Spread Withdrawals Over All Ten Years
The most straightforward method is to take annual withdrawals designed to keep you within your current tax bracket. By pulling out only enough to “fill” your existing bracket without spilling over into the next, you can limit the amount of income taxed at higher rates.
For example, if you are in the 22 percent bracket and have $30,000 of space before you hit the 24 percent bracket, you could withdraw up to that amount from the inherited IRA each year. While this may not completely avoid higher brackets over the next 10 years, it helps minimize the damage.
2. Time Withdrawals for Low-Income Years
If you anticipate years with lower-than-normal income, consider deferring larger distributions until those periods. This might apply if you are planning to retire, take a sabbatical, or transition careers.
For instance, if you are currently working in a high-paying role but plan to retire in three years, your tax bracket could drop significantly afterward. Waiting to take larger distributions until you are in that lower bracket can substantially reduce taxes.
Similarly, if you start a business and expect a year or two of lower income during the startup phase, those years could be ideal for taking larger IRA withdrawals.
3. Offset IRA Income with Other Tax Strategies
Another approach is to match distributions from the inherited IRA with deductions or other tax-reducing moves. Examples include:
- Charitable Giving – Making a sizable donation to a donor-advised fund in the same year as a large IRA withdrawal can offset taxable income.
- Increased Retirement Contributions – If you have a 401(k) or other employer plan, you could contribute more in a given year while using the IRA withdrawals to replace that income. This can keep your taxable income steady.
- Business Retirement Plans – If you are self-employed, establishing a retirement plan for your business can provide additional deduction opportunities.
- State Tax Planning – If you plan to move to a state with no income tax, delaying distributions until after your move could save a significant amount.
The Importance of Forecasting and Professional Guidance
The key to successful inherited IRA planning is looking ahead. Forecasting your future income, anticipated tax rates, and life changes can help you decide when to take distributions and how much to take each year.
Financial planners often use tax modeling tools to project different withdrawal strategies and see their effect over the full 10-year period. A CPA can also be invaluable in making sure the plan is executed correctly and in compliance with tax laws.
Failing to plan can lead to unnecessary taxes that erode the legacy your loved one intended to leave you. By taking a thoughtful approach, you can keep more of the money working for your own financial goals.
Key Takeaways
- The 10-year rule requires non-eligible designated beneficiaries to fully deplete an inherited IRA within 10 years.
- Roth IRAs offer tax-free growth and withdrawals, so delaying distributions is often the best choice.
- Traditional IRAs require careful planning to avoid pushing withdrawals into higher tax brackets.
- Spreading withdrawals over the 10-year period, targeting low-income years, and pairing distributions with other tax strategies can all help reduce taxes.
- Professional advice from a financial planner and a CPA can ensure your strategy is both tax-efficient and compliant with IRS rules.
Final Thoughts
An inherited IRA can be both a valuable financial gift and a tax challenge. The rules are strict, but the strategies to manage them are flexible enough to adapt to your personal situation. Whether you choose to spread withdrawals evenly, time them for your lowest income years, or offset them with other tax moves, the important thing is to have a plan in place.
Your loved one worked hard to leave you this inheritance. With careful planning, you can honor that legacy by keeping more of it for your future rather than sending a large portion to the IRS.
If you find yourself unsure about the best approach, consider scheduling a call to discuss your needs, talk through your situation, and help you make the most of your inherited IRA.
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