Retired Military Finances 301: I Inherited Mom's (or Dad's) IRA. How do I Minimize my Tax Bill?

In the good old days if you inherited an IRA, you could take distributions using your life expectancy as a starting point and stretch the distributions over decades. This typically allowed the person that inherited the IRA to minimize the tax burden of the inherited IRA. Then in 2019, Uncle got a bit greedy. The SECURE Act significantly limited the amount of time a non-spouse beneficiary had to distribute the entire balance of the IRA (there are some exceptions, but in general the new rule applies to most non-spouses).

How Did the SECURE Act Change Distributions from Inherited IRAs?

As mentioned above prior to the SECURE Act, you could typically stretch out the distributions for decades. The SECURE Act limits you to a maximum of 10 years. Said another way, the account must be empty by the end of the 10th year following the year of the owner’s death. But wait there is more. If the IRA owner had started taking Required Minimum Distributions (RMD) prior to death, you must continue to take distributions AND empty the account by the end of the 10-year limit. Jeff Levine, a smart guy I listen to, calls this the Pringle’s rule. Once you pop, you just can’t stop. The good news is that your RMDs are still based on your life expectancy so your required annual distribution should be less than your parent's. That doesn’t mean you should only take the minimum each year. That could cause problems with your taxes.

If you do inherit an IRA and you’re not a spouse, you basically have 3 strategies to keep yourself out of higher tax brackets and minimize your tax burden.

Leave the account alone for as long as possible
Turn the 10-year rule into an 11-year rule
Strategically time distributions from the inherited account

Leave the Account Alone for as Long as Possible

If your parent passes away prior to the Required Beginning Date (RBD) and didn’t start taking RMDs, you can wait until the 10th year to take any money out. Or if you parent passed away after the RBD, you can take the minimum amount based on your life expectancy and take out the entire remaining balance in the 10th year. When might you want to do this?

If you’re already in the highest tax bracket, you don’t really need to worry about a big distribution in year 10 pushing you into a higher bracket. If this applies to you, you might as well get the max tax deferral and take out the minimum amount possible each year until year 10.

If it is a Roth account, you can wait as well as a big distribution in the 10th year won’t affect your tax bracket. One school of thought holds that since Roth accounts don’t have a RBD, you can push off everything until the last year.

Finally, if the account balance is small and really won’t affect your tax bracket, you can delay as long as you can with little to no tax ramifications

Turn the 10-Year Rule Into an 11-Year Rule

You have 10 years after the year of death to distribute all funds from the IRA. What about the year of death (year 0)? If Mom or Dad is RBD age and older AND took their RMD for the year of death, prior to death, it will be taxable to them and you can take another distribution in the year of death and pay your taxes. This extra year of distributions might spread the distributions out enough to keep you out of a higher tax bracket. If Mom or Dad hasn’t hit the RBD by the year of death, you could also take a distribution in year 0 with the same results. Of course, this assumes the account transfers and admin all take place in time for you to take a distribution before year end.

Strategically Time Distributions

Depending on whether your parent(s) was past the RBD you’ll have to take out a minimum amount or you won’t have to take out anything. In the two situations above your taxable income is assumed to be pretty much level. Life is rarely that simple. Maybe you’re going to retire during the 10-year period. It might make sense to wait to take larger distributions until after you retire. Or maybe you’re going to upgrade from First Officer to Captain in about 4 years. Might make sense to front-load the distributions. Or maybe you can bunch charitable contributions and property taxes into a single year and take a bigger distribution in that year. There are literally hundreds of permutations.

This Stuff is Tricky

I’ve said it before and I’ll say it again, “Dealing with inherited IRA RMDs is the most complicated thing in the Tax Code.” Take some time and figure it out before you start moving money.

Military Finances are Different

The inherited IRA rules apply to all taxpayers, whether military or not. That isn't always the case. Military members have different rules when it comes to determining if their house qualifies for the primary residence exclusion. That's why we think you should work with a financial planner or advisor that routinely works with Active and Retired Senior Military Officers and NCOs. If you'd like to find out how we help clients just like you, use the button below to schedule a free, initial consultation.

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