Inheriting an IRA can provide meaningful financial support, but it also comes with important tax and distribution rules that are easy to misunderstand. Changes under The SECURE Act have made inherited IRA planning even more complicated for many beneficiaries.
Without a proper strategy, mistakes can lead to unnecessary taxes, penalties, and lost growth opportunities.
Here are some of the most common inherited IRA mistakes to avoid.
1. Missing Required Distribution Deadlines
Many non-spouse beneficiaries are now required to fully distribute inherited IRA assets within 10 years of the original owner’s death. In some cases, annual required minimum distributions (RMDs) may also apply during that period.
Failing to follow the withdrawal schedule can result in IRS penalties, making it important to understand the rules that apply to your specific situation.
2. Cashing Out the Entire Account Too Quickly
One of the most common mistakes beneficiaries make is withdrawing the entire inherited IRA balance immediately.
Because distributions from traditional IRAs are generally taxed as ordinary income, a large lump-sum withdrawal could push you into a higher tax bracket and increase your overall tax liability.
Spreading withdrawals over several years may help reduce taxes while allowing the remaining assets to continue growing tax-deferred.
3. Incorrectly Retitling the IRA
Inherited IRAs must be titled properly to maintain their tax advantages. Non-spouse beneficiaries generally cannot transfer inherited IRA funds directly into their own IRA.
Improper transfers or account setup errors may trigger unnecessary taxes or penalties. Working closely with the IRA custodian can help ensure the account is handled correctly.
4. Waiting Until Year 10 to Withdraw Funds
Some beneficiaries assume they can wait until the final year of the 10-year rule to withdraw the entire balance. However, this strategy can create a significant tax burden if the account has grown substantially over time.
A gradual withdrawal strategy may help spread taxable income more efficiently across multiple years.
Related Reading: Financial Planning Checklist: How to Take Inherited IRA Distributions
5. Overlooking Special Rules for Spouses
Spousal beneficiaries often have more flexibility than other beneficiaries. Depending on their financial situation, a surviving spouse may choose to:
- Roll the IRA into their own account
- Remain a beneficiary
- Delay distributions longer
The best option depends on factors such as age, retirement timeline, and income needs.
Related Reading: The 99% Rule for Spousal Beneficiaries of IRAs
6. Ignoring Roth IRA Distribution Rules
Although qualified Roth IRA distributions are generally tax-free, inherited Roth IRAs still follow specific distribution timelines.
Proper planning can help beneficiaries maximize continued tax-free growth while staying compliant with IRS rules.
7. Failing to Update Beneficiary Designations
Many inherited IRA issues begin with outdated beneficiary arrangements. Beneficiary designations typically override instructions in a will, making regular reviews essential.
Major life events such as marriage, divorce, births, or deaths should prompt a review of all retirement account beneficiaries.
Inherited IRA rules can be complex, and even small mistakes may have long-term financial consequences. Understanding distribution requirements, tax implications, and beneficiary options can help preserve more of the inheritance and reduce unnecessary taxes.
Working with a financial professional can help beneficiaries create a strategy that aligns with both their financial goals and current IRS regulations.
Bautis Financial LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
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