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If you\u2019ve inherited an individual retirement account<\/a>, you may have big plans for the balance \u2014 but costly mistakes can quickly shrink the windfall, experts say.<\/p>\n Many investors roll pre-tax 401(k) plans into traditional IRAs<\/a>, which trigger regular income taxes<\/a> on future withdrawals. The tax rules are complicated<\/a> for the heirs who inherit these IRAs.<\/p>\n The average IRA balance<\/a> was $127,534 during the fourth quarter of 2024, up 38% from 2014, based on a Fidelity analysis of 16.8 million IRA accounts as of Dec. 31.<\/p>\n But some inherited accounts are significantly larger, and errors can be expensive, said IRA expert Denise Appleby, CEO of Appleby Retirement Consulting in Grayson, Georgia.<\/p>\n More from Personal Finance:<\/strong> Here are some big inherited IRA mistakes and how to avoid them, according to financial experts.\u00a0<\/p>\n<\/div>\n Before the Secure Act<\/a> of 2019, heirs could empty inherited IRAs over their lifetime to reduce yearly taxes, known as the \u201cstretch IRA.\u201d<\/p>\n But since 2020, certain heirs must follow the \u201c10-year rule,\u201d and IRAs must be depleted by the 10th year after the original account owner\u2019s death. This applies to beneficiaries who are not a spouse, minor child, disabled, chronically ill or certain trusts.<\/p>\n Many heirs still don\u2019t know how the 10-year rule works, and that can cost them, Appleby said.<\/p>\n If you don\u2019t drain the balance within 10 years, there\u2019s a 25% IRS penalty on the amount you should have withdrawn, which could be reduced or eliminated if you fix the issue within two years.<\/p>\n<\/div>\n For pre-tax inherited IRAs, one big mistake could be waiting until the 10th year to withdraw most of the balance, said certified financial planner Trevor Ausen, founder of Authentic Life Financial Planning in Minneapolis.<\/p>\n \u201cFor most, it\u2019s a ticking tax bomb,\u201d and the extra income in a single year could push you into a \u201cmuch higher tax bracket,\u201d he said.<\/p>\n<\/div>\n Similarly, some heirs cash out an inherited IRA soon after receiving it without weighing the tax consequences, according to IRA expert and certified public accountant Ed Slott. This move could also bump you into a higher tax bracket, depending on the size of your IRA.<\/p>\n \u201cIt\u2019s like a smash and grab,\u201d he said.<\/p>\n Rather than depleting the IRA in one year, advisors typically run multi-year tax projections to help heirs decide when to strategically take funds from the inherited account.<\/p>\n Generally, it\u2019s better to spread out withdrawals over 10 years or take funds if there\u2019s a period when your income is lower, depending on tax brackets, experts say.\u00a0<\/p>\n<\/div>\n Starting in 2025, most non-spouse heirs must take required minimum distributions<\/a>, or RMDs, while emptying inherited IRAs over 10 years, if the original account owner reached RMD age before death, according to final regulations<\/a> released in July.<\/p>\n That could surprise some beneficiaries since the IRS previously waived penalties<\/a> for missed RMDs from inherited IRAs, experts say.<\/p>\n While your custodian calculates your RMD, there are instances where it could be inaccurate, Appleby explained.<\/p>\n<\/div>\n For example, there may be mistakes if you rolled over a balance in December or there\u2019s a big age difference between you and your spouse.<\/p>\n \u201cYou need to communicate those things to your tax advisor,\u201d she said.<\/p>\n Generally, you calculate RMDs<\/a> for each account by dividing your prior Dec. 31 balance by a \u201clife expectancy factor\u201d provided by the IRS.<\/p>\n If you skip RMDs or don\u2019t withdraw enough in 2025, you could see a 25% IRS penalty on the amount you should have withdrawn, or 10% if fixed within two years.<\/p>\n But the agency could waive the fee \u201cif you act quickly enough\u201d by sending Form 5329<\/a> and attaching a letter of explanation, Appleby said.<\/p>\n
This inherited IRA rule change for 2025 could trigger a 25% tax penalty<\/a>
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Treasury scraps reporting rule for U.S. small business owners<\/a><\/p>\nWhat to know about the \u201910-year rule\u2019<\/h2>\n
Inherited IRAs are a \u2018ticking tax bomb\u2019<\/h2>\n
Many heirs must take RMDs in 2025<\/h2>\n