Inherited IRAs can grow family wealth — and create a tax headache. Here’s how to limit it

An inherited individual retirement account can be a meaningful financial boost for some beneficiaries, but without careful planning, taxes can quickly reduce the value, experts say.

According to a recent Vanguard report that reviewed nearly 83,000 accounts in 2024, heirs receive inherited IRAs at an average age of 59, and the average account balance is $128,000.

"Most people inherit an IRA in their 50s, right at the peak of their earning years, and then have to empty it within 10 years," said certified financial planner Michael Walstedt, founding advisor of Reliant Wealth Advisory in Hoboken, New Jersey.

Since 2020, a "10-year rule" has applied to some inherited accounts, requiring certain heirs, including adult children, to generally withdraw the full balance by the 10th year after the original account owner's death.

If the inherited IRA is pretax, that 10-year withdrawal schedule can raise adjusted gross income, which may lead to higher taxes and reduce access to other tax benefits, experts say.

Planning for inherited IRAs is likely to remain important as the so-called "great wealth transfer" continues, with baby boomers expected to pass trillions of dollars to Gen Xers and millennials over the coming decades.

UBS estimated in a recent report that total transfers between generations could reach $74 trillion over the next 20 to 25 years.

Whether you are preparing to leave assets behind or expect to inherit an IRA, financial experts say there are several tax moves worth considering.

Inherited IRA withdrawals need a strategy

Some adult children who inherit an IRA generally must begin taking required minimum distributions, or RMDs, over the 10-year period or face an IRS penalty. That yearly RMD rule applies if the original IRA owner had already reached RMD age, usually 73, before death.

Even when annual RMDs are not required during the 10-year period, experts say heirs still need a withdrawal plan for pretax inherited accounts. Otherwise, they may be forced to take a large distribution in the final year, creating a much bigger tax bill than expected.

"I recommend projecting income over those 10 years and planning withdrawals around it," said CFP James Mayo, founder of IronFjord Wealth Management in Lakewood, Colorado.

For instance, if you expect lower-income years because of retirement or a sabbatical, those periods may place you in a lower tax bracket and create an opportunity to take larger IRA distributions, he said.

Think about your heirs' tax brackets

Original account owners should also weigh each beneficiary's income tax bracket when deciding who receives the IRA, said certified public accountant Tim Steffen, director of advanced planning at financial services firm Baird.

For example, if one child is a law firm partner and another is a teacher, "their incomes are wildly different," he said.

In that situation, it may make sense to leave more of the IRA to the teacher, who would likely owe less income tax, while leaving a tax-free life insurance policy to the higher-earning attorney, Steffen said.

"Be more thoughtful about who actually inherits what, instead of just saying everybody gets an equal share of everything," he said.

The case for Roth conversions

If you are the original account owner, converting to a Roth IRA during your lifetime "can make a big difference" for heirs, according to CFP Dinon Hughes, a partner with Nvest Financial in Portsmouth, New Hampshire.

Roth conversions move pretax or nondeductible IRA funds into a Roth IRA, where growth can continue tax-free. The conversion creates taxable income in the year it happens, but it can leave heirs with more tax-free money later, experts say.

Although some inherited Roth IRAs are still subject to the 10-year rule, beneficiaries can generally take the money out tax-free.

"The sweet spot for Roth conversions" is often early retirement, when income is lower before Social Security begins and before required minimum distributions start, Hughes said.

Still, tax projections are important to determine how additional income could affect other breaks, including the $6,000 senior "bonus" deduction.

Higher adjusted gross income can also influence income-related monthly adjustment amounts, or IRMAAs, which can push up Medicare Part B and Part D premiums once income crosses a certain threshold.