These inherited IRA mistakes could reduce your windfall, advisors say

Key Inherited IRA Errors Investors Should Avoid to Protect Their Wealth

Imagine you’ve just inherited a big box of puzzle pieces. If you don’t put them together the right way, you could lose some pieces—or even face a penalty! This is what it’s like to inherit an IRA (Individual Retirement Account). For investors, understanding the rules is important, because making mistakes can cost real money.

Why Inherited IRAs Matter for Investors

Inherited IRAs are in the spotlight because of the “great wealth transfer.” Experts estimate over $100 trillion will move from older generations to younger ones by 2048. Cerulli Associates says this could impact millions of families. If you inherit an IRA, the choices you make can affect your taxes, investment returns, and even your family’s financial future.

Bulls: The Upside of Inherited IRAs

  • Potential for Growth: If you manage the investments wisely, an inherited IRA can keep growing tax-deferred for up to 10 years.
  • Flexible Withdrawals: You have some freedom to choose when to take money out, which can help with tax planning.
  • Family Wealth Building: Smart use of inherited IRAs can help families build wealth across generations.

Bears: The Risks and Downsides

  • IRS Penalties: If you don’t follow the rules, you might have to pay a 25% penalty on missed withdrawals. This can drop to 10% if you fix the mistake quickly, but it’s still a big hit.
  • Big Tax Bills: Inherited IRAs (especially traditional, pre-tax ones) mean you’ll owe income taxes on withdrawals. Taking out too much in one year could bump you into a higher tax bracket.
  • Complicated Rules: Since 2020, most non-spouse heirs must empty the account within 10 years, and starting in 2025, some must take yearly “required minimum distributions” (RMDs). Missing these can be costly.

Three Common Mistakes (and How to Avoid Them)

  • Not Knowing the Rules:

    • If you’re not a spouse, you likely need to empty the IRA within 10 years of inheriting it.
    • Starting in 2025, many heirs must take a minimum amount out each year, or face big penalties.
    • Always double-check the rules for your situation or talk to a financial advisor.
  • Not Planning for Taxes:

    • Every dollar you withdraw is taxed like regular income. That could mean a surprise tax bill, especially if you wait and take a lump sum at the end.
    • Many experts suggest spreading out withdrawals—especially in years when your income is lower—to keep taxes manageable.
    • A study from the Kitces financial blog shows that careful planning can save heirs thousands of dollars in taxes.
  • Keeping the Same Investments:

    • The investments in the IRA may not fit your goals or how much risk you want to take.
    • It’s smart to review and possibly change the investments to match your needs and the 10-year timeline.
    • Be careful with investments like certificates of deposit (CDs) that lock up money beyond when you need to take it out for RMDs.
Related:  2026 Tax Brackets Updated: Key Changes Investors Should Know for Financial Planning

Investor Takeaway

  • Learn the rules: If you inherit an IRA, find out if you need to take yearly withdrawals and when you must empty the account.
  • Plan for taxes: Use a tax advisor or online calculators to figure out the best withdrawal strategy for your situation.
  • Update investments: Make sure the IRA’s investments match your goals and the required withdrawal schedule.
  • Don’t go it alone: Consider talking to a financial advisor to avoid costly mistakes and penalties.
  • Stay informed: Rules can change, so keep up with the latest IRS guidance or ask for professional help if you’re unsure.

For the full original report, see CNBC

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