Key Takeaways
- An heir was told that the roughly $35,000 inherited IRA from a grandmother wouldn’t be taxed for 10 years, and asked about taking $10,000 out now.
- Money left in an inherited traditional IRA isn’t taxed until it comes out, but each withdrawal is taxable income in the year it’s taken.
- At an assumed 22% tax rate, a $10,000 withdrawal this year costs $2,200 in federal income tax.
- A grandchild can’t roll the account into their own IRA or put a withdrawal back, so moving it to a credit union has to be a trustee-to-trustee transfer into a new inherited IRA.
If you’ve just inherited an IRA from a parent or grandparent, you’ve probably heard about the 10-year rule. And there’s good news in it: whatever stays in the account grows without a tax bill until it comes out. But it’s easy to hear that as 10 years without a tax bill on any of it, when every dollar you take out along the way goes on that year’s tax return.
One heir’s $10,000 question
One person posting in Reddit’s r/personalfinance forum this weekend ran into exactly this. The poster just inherited about $35,000 from a grandmother. The man handling her accounts and splitting them among the heirs mentioned what the poster figures is an inherited IRA. The way the poster understood him, the money and its gains wouldn’t be taxed for 10 years, and then it would be rolled over or used for something. Eventually, the poster expects the money to go toward an addition on the house or into retirement savings, and the first question in the post was a natural one: “Can I take $10k and put the rest in an IRA?”
Ten years to empty it, and no do-overs
Most heirs who aren’t a spouse have until the end of the 10th year after the owner’s death to empty an inherited IRA. That rule covers owners who died after 2019. If the poster’s grandmother died this year, the deadline is Dec. 31, 2036. So nothing gets rolled over at the end of the 10 years, because by then the account has to be empty.
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A grandchild also can’t treat the inherited account as their own, the IRS says in Publication 590-B. So the poster can’t roll it into their own IRA, and once money comes out, it can’t go back in. The only way to move the account to another firm is a trustee-to-trustee transfer into a new IRA set up in the grandmother’s name for the poster’s benefit as beneficiary.
The $10,000 goes on this year’s return
Money taken out of an inherited traditional IRA is taxed as ordinary income in the year it comes out. So $10,000 withdrawn before Dec. 31 is $10,000 of extra income on the poster’s return for this year. The poster didn’t say what they earn, so let’s say their top bracket is 22%. That’s $2,200 of federal income tax, which leaves $7,800 to spend. At least there’s no 10% early-withdrawal penalty on top, whatever the poster’s age, since the money came to them because the owner died.
Ask for a transfer, and pick the year
The poster also asked about having the advisor hand over all the money so the credit union could set up the IRA. That only works one way. The credit union opens an inherited IRA in the grandmother’s name for the poster’s benefit, and the money moves straight from one firm to the other in a trustee-to-trustee transfer. If the advisor cuts the poster a check instead, the whole inheritance counts as a withdrawal, and none of it can go back into an IRA. On the full $35,000, that’s $7,700 of federal income tax at the same assumed 22%, and possibly more, since $35,000 of extra income in one year can push some of it into a higher bracket. Ouch.
The poster also gets to choose which year the $10,000 counts in. Money withdrawn by Dec. 31 goes on this year’s return, and money taken in January goes on next year’s. So if this year’s income is high, waiting a few weeks could keep the withdrawal out of a higher bracket. Over the 10 years, the poster can also spread withdrawals across several returns, so no single year’s income takes the whole hit.
Take the $10,000, and plan for the $2,200
If the addition is happening anyway, I’d take the $10,000 and not lose sleep over it. Just set aside $2,200 of it for taxes (or whatever the poster’s actual bracket works out to), and leave the other $25,000 or so to grow untaxed for as long as the deadline allows. Of course, the poster only thinks it’s an inherited IRA. So the first call should be to the person handling the estate, to find out exactly what kind of account it is before a dollar moves.
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. Our analysis might not include recent company news or important updates. TIKR has no position in any of the stocks mentioned. Thank you for reading, and happy investing!
