How to Save Tax by Planning Your Inherited IRA Withdrawals the Smart Way

Imagine this, you inherit a $500,000 IRA from your parent. If you withdraw all the money in one year, that extra $500,000 could easily push you into a much higher tax bracket, costing you tens of thousands more in income taxes. But if you spread withdrawals evenly over 10 years, you might stay in a lower tax bracket and save upwards of $40,000 in taxes.. for one year.. That is the power of smart tax planning for inherited IRAs.

Here’s what it means in simple terms:

• If you withdraw the entire inherited IRA in one year, the whole amount counts as income on your tax return for that year. This can bump you into a higher tax bracket and make you pay a much larger portion in taxes all at once.

• If you spread the withdrawals over 10 years, you only add a smaller portion (for example, $10,000 per year from a $100,000 IRA, or $50,000 per year from a $500,000 IRA) to your income each year. This helps keep you in a lower bracket and reduces how much you owe in taxes overall.

Why 2025 Brings Big Changes for Inherited IRAs
Starting in 2025, the IRS is enforcing stricter rules for inherited IRAs. Most beneficiaries must now take required minimum distributions (RMDs) every year and fully withdraw the account by the end of the tenth year after the original owner’s death. Failing to take these RMDs can lead to penalties as high as 25 percent of the amount you should have withdrawn.

The End of the “Stretch IRA”
Before the SECURE Act of 2019, many beneficiaries could “stretch” distributions over their lifetime, keeping more money growing tax-deferred for decades. The new rules ended this benefit for most non-spouse beneficiaries, replacing it with the 10-year payout requirement.

Special Options for Surviving Spouses
If you inherit an IRA from your spouse, you have some unique advantages:

1. Treat the IRA as your own. That means the account becomes yours, and it’s treated just like your own retirement account. However, if you then withdraw money before you turn 59½, you’ll owe a 10 percent early withdrawal penalty, just like anyone taking money early from their own IRA.

   You can delay RMDs until the year your spouse would have turned 75. For example, if your spouse passed away at 55 in 2024, you could wait until 2045 to start taking distributions. This allows your money to keep growing tax-deferred for 20 more years.

2. Stay as a beneficiary. This means you stay listed as the beneficiary instead of transferring ownership to yourself. The big advantage is that you can withdraw money at any age without paying that 10 percent early withdrawal penalty. You’ll still owe income taxes on the withdrawals (unless it’s a Roth IRA), but there’s no penalty for taking money out before age 59½.

   If you are younger than 59½, you can take withdrawals without the early withdrawal penalty by keeping the account as an inherited IRA.

For Roth IRAs, you can assume ownership and never take RMDs at all. This lets the funds grow tax-free for your lifetime and can help you pass more money to future generations.

Special Rules for Minor or Disabled Beneficiaries
Minor children do not have to start the 10-year withdrawal clock until they turn 21, giving them more time to plan. Disabled or chronically ill beneficiaries can continue using life expectancy distributions indefinitely, avoiding the 10-year rule entirely.

Smart Planning for Non-Spouse Beneficiaries
If you inherit an IRA from someone who is not your spouse, the key to saving on taxes is how you time your withdrawals. Taking out equal amounts each year often keeps you in a lower tax bracket. You can also adjust withdrawals depending on whether you expect tax rates to rise or fall in the future.

• Example: How Timing Withdrawals Can Save Thousands

  • Let’s say you inherit a $500,000 traditional IRA from your father in 2025. You’re 45 years old, working full time, and already earn $120,000 per year.

• Option 1: Withdraw All at Once

  • If you take the full $500,000 in 2025, your taxable income jumps from $120,000 to $620,000 that year. That would push you into the highest tax brackets, and you could easily owe over $150,000 in federal taxes alone on that withdrawal.

• Option 2: Spread Withdrawals Over 10 Years

  • Instead, you could withdraw about $50,000 per year for 10 years. That means your income would rise to $170,000 annually, keeping you in a much lower tax bracket. Depending on your situation, you might save $40,000 to $60,000 in total taxes over that 10-year period compared to taking it all at once.

• Option 3: Time Withdrawals Based on Future Tax Rates

  • Suppose you plan to retire in 5 years and expect your income to drop sharply. You could:

  • Withdraw smaller amounts during your high-income years (while you’re still working)

  • Take larger withdrawals later, once you’re retired and in a lower tax bracket

  This approach could reduce your lifetime tax bill even further, especially if you combine it with charitable giving or Roth conversion strategies.

Your Key Takeaways

• Act early, since 2025 penalties for missed RMDs will be enforced.

• If you are a surviving spouse, decide whether to be treated as the owner or the beneficiary based on your age and financial goals.

• If you are a minor child, know when the 10-year countdown begins.

• If you are another type of beneficiary, plan your withdrawals carefully to minimize taxes and penalties.

By understanding these new IRS rules and planning your withdrawals wisely, you can keep more of your inherited money working for you instead of losing it to taxes.