28 Oct Can I take from inherited IRA and avoid the taxes?

Q. I have an inherited IRA. I haven’t yet scheduled withdrawals. My family recently incurred large medical bills and loss of income due to illness. I was planning to withdraw a lump sum from the inherited IRA and have the appropriate taxes withheld. However, my financial advisor seems to think there are tax exemptions for this type of use. Can a partial lump sum inherited IRA withdrawal be tax exempt for certain uses in New Jersey?
— Unsure

A. The rules surrounding inherited IRA distributions can be complicated.

We’re glad you want to get it right.

Much depends on the timing of when you inherited the account.

First, because this is an inherited IRA, if you’re younger than 59 1/2 years old, no early withdrawal penalty applies, said Michael Maye, a certified financial planner and certified public accountant with MJM Financial in Gillette.

He said it used to be for IRAs that were inherited by a non-spouse, funds could be withdrawn over a much longer period in what were labeled a “stretch IRA.”

But those with inherited IRAs post-2019 who don’t meet an exception — being a spouse, minor child, disabled or chronically ill — are required to fully distribute the account by the end of the tenth year after the original account owner’s death, Maye said.

“There was much confusion over the new rules,” he said. “The IRS is now saying that those who inherited IRAs from an original IRA holder who was already in RMD mode would also need to take an annual RMD in addition to fully draining the account by the end of year 10.”

The IRS recently issued a statement saying the final rules around this wouldn’t be issued until 2023, and in the meantime, those who inherited IRAs during 2020 and 2021 would not be subject to the 50% penalty for failure to take inherited IRA required distributions during the 2021 and 2022 tax years, he said.

To your specific question:

“First, I would encourage the reader to look at their other assets that they have either in the bank or taxable brokerage accounts as it might be more tax efficient to tap those dollars first,” Maye said.

You also said there was a loss of income due to the illness, so depending on how much income was lost and the size of the medical bill, there might be a smaller impact if you take a lump sum from their inherited IRA than otherwise would have happened, he said.

“Assuming the reader needs to take a lump sum from their inherited IRA to help pay the medical bills, the tax break they would get is as an itemized medical deduction on their federal income tax return,” Maye said. “However, many taxpayers these days take the standard deduction on their federal return rather than an itemized deduction due to the state and local tax limitation better known as SALT.”

New Jersey also allows a medical expense deduction in excess of 2% of gross income, Maye said, noting the medical expenses that qualify for New Jersey are the same as those that would qualify for federal tax purposes.

“So even if the reader takes the standard deduction for federal income tax purposes, they can still itemize medical expenses in excess of 2% of their gross income on their New Jersey income tax return,” Maye said. “So, what the financial advisor was likely referring to was a potential New Jersey medical expense itemized deduction rather than a tax exemption for an inherited IRA withdrawal.”

Also note that if it was your own IRA and you were under 59 1/2 years old, you might qualify for IRA hardship withdrawal and avoid the IRS 10% penalty for taking an early distribution.

Consider sitting down with a qualified tax preparer who can take a closer look at your specifics.

Email your questions to .

This story was originally published on Oct. 28, 2022.

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.