Inherited IRA Taxes Are Draining Your Future

Inherited an IRA? Here’s What Federal and Postal Employees Need to Know About Taxes

If you’re a federal or postal employee who has inherited an IRA, you might be wondering: Is an inherited IRA taxable? The answer depends on several factors, including the type of IRA and your relationship to the original account holder. Understanding the tax implications is crucial to avoid unexpected tax bills and penalties.

Understanding Inherited IRAs

An inherited IRA is a retirement account passed on to a beneficiary after the original owner’s death. As a federal or postal employee, you might inherit such an account from a spouse, parent, or another relative. The tax treatment of the inherited IRA depends on the type of IRA and your relationship to the deceased.

Tax Implications Based on IRA Type

Traditional IRA

Distributions from an inherited traditional IRA are generally considered taxable income. This means you’ll owe income tax on the amounts you withdraw. The IRS requires beneficiaries to take distributions, which are subject to ordinary income tax rates.

Roth IRA

If you inherit a Roth IRA, the distributions are typically tax-free, provided the account was open for at least five years before the original owner’s death. This can be a significant advantage, allowing the funds to grow tax-free and be withdrawn without tax consequences. However, you are still required to follow certain distribution rules.

Distribution Rules: The SECURE Act’s Impact

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, effective January 1, 2020, introduced new rules for inherited IRAs. Most non-spouse beneficiaries are now required to withdraw the entire balance of the inherited IRA within 10 years of the original owner’s death. This is known as the “10-year rule.” There are no required minimum distributions (RMDs) during this period, but the account must be fully depleted by the end of the 10th year.

For example, if you inherited a traditional IRA in 2021, you must withdraw all funds by December 31, 2031. Failing to do so can result in significant tax penalties.

Exceptions to the 10-Year Rule

Certain beneficiaries, known as “eligible designated beneficiaries,” are exempt from the 10-year rule and can take distributions over their life expectancy. These include:

• Surviving spouses

• Minor children of the deceased (until they reach the age of majority)

• Individuals with disabilities

• Chronically ill individuals

• Individuals not more than 10 years younger than the deceased

As a federal or postal employee, if you fall into one of these categories, you may have more flexibility in managing the inherited IRA.

Spousal Inheritance Options

If you inherit an IRA from your spouse, you have additional options:

1. Treat the IRA as your own: You can roll the inherited IRA into your own IRA, allowing you to delay distributions until you reach age 73 (or 75, depending on your birth year).

2. Remain a beneficiary: You can keep the inherited IRA as a beneficiary, which may be beneficial if you are younger than 59½ and need to access the funds without early withdrawal penalties.

Choosing the right option depends on your financial situation and retirement plans.

Reporting Inherited IRA Distributions

Distributions from an inherited IRA are reported on IRS Form 1099-R. It’s essential to include this income on your tax return accurately. If the inherited IRA includes non-deductible contributions, you may need to file Form 8606 to calculate the taxable portion of the distributions.

Action Steps for Federal and Postal Employees

1. Identify the type of inherited IRA: Determine whether it’s a traditional or Roth IRA.

2. Understand your beneficiary status: Are you a spouse, non-spouse, or eligible designated beneficiary?

3. Review distribution requirements: Know the deadlines and rules for taking distributions to avoid penalties.

4. Consult The Benefit Coordinators: Seek professional guidance to develop a strategy that aligns with your retirement goals and minimizes tax liabilities.

Conclusion

Inheriting an IRA can be a valuable addition to your retirement savings, but it’s crucial to understand the tax implications and distribution rules. As a federal or postal employee, being informed will help you make the best decisions for your financial future.

For personalized assistance with your retirement planning, including managing inherited IRAs, contact The Benefit Coordinators. Our experts are here to help you navigate your options and secure your financial well-being.