22 Apr Can I avoid taking money from an inherited IRA?

Q. I inherited a small IRA when my mom died. Is there any way to avoid income taxes? I don’t need the income at this time and can keep it in an IRA?
— Unsure

A. We’re sorry to hear about your mother.

And unfortunately, there are new rules on how inherited IRAs are distributed, and you won’t be able to avoid paying taxes on the money.

But you do have some time.

If you inherited the IRA from your mom on or after Jan. 1, 2020, you must withdraw all the assets in the account within 10 years, said Jeanne Kane, a certified financial planner with JFL Total Wealth Management in Boonton.

The SECURE Act, which went into effect in 2020, eliminated the ability for you to stretch the distributions over your lifetime, she said.

To add to the confusion, the IRS last week updated a publication that covered when distributions must be taken. Financial professionals had been expecting investors need not take annual minimum distributions during the 10-year period, but now it appears annual distributions will indeed be required.

If you inherited a traditional IRA, you’ll pay taxes on 100% of what you withdraw because the money wasn’t taxed when your mom put it in, Kane said.

“She deferred paying taxes and now you pay them when you take the money out,” she said.

There are several different ways you can manage your distributions, keeping taxes in mind.

You could take the same withdrawal each year, she said.

“This makes sense if you expect your income to remain consistent over the next 10 years,” Kane said. “You are spreading the tax hit equally across 10 years.”

You could also take irregular distributions.

“If your income varies year to year, you may choose to withdraw more in years when your income is lower and you’re in a lower tax bracket, so you’ll pay less in taxes,” she said.

Your other option is to empty the entire account at 10 years, but remember that those annual distributions are expected to be required.

Keep in mind that if you think your income will drop in the future, such as when you retire, you may want to wait to take your distribution at year 10 or even the final few years. That’s because your income may be lower in retirement and you may be in a lower tax bracket, Kane said.

If it’s a Roth IRA, you could let the money ride for the next 10 years to benefit from 10 years of tax-free growth, Kane said.
Kane said if you’re worried about taxes, there is a strategy you can use to neutralize the tax impact of the inherited IRA withdrawals.

If you’re not contributing the maximum to your 401(k), which is $19,500 plus another $6,500 if you are over 50, you can increase your contribution, which will reduce your taxable income, she said.

“Take a distribution from your inherited IRA for the same amount. This increases your taxable income,” she said. “Then the 401(k) contribution offsets the income you take out from the inherited IRA. It is tax neutral.”

You should discuss the specifics with a pro to help you understand the best withdrawal strategy for you.

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This story was originally published April 22, 2021.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.