Inheritance Maintenance

Planning for your children

Before 2020, adult children inheriting a parent IRA, they were able to withdraw the funds over their lifetime.  For example, if an adult child inheritance $500,000, they may have been able to withdraw about $20,000 a year for almost their lifetime.  However, a 2020 law change now force the beneficiary of an IRA inheritance to take all the money out within 10 years.  Thus, a $500,000 inheritance would need to be taken out on average $50,000 a year for 10 years.

If the goal of the parent is to have your adult children to have funds over a lifetime, you will need to explain to them your goals and provide examples on how this can be down.  

Possible plan that you may use with your adult children. Please note that some states have an inheritance tax (i.e. Pennsylvania).

Children inheriting parent’s IRA and Roth IRA

Below is a sample note that may be share with your adult children:

I suggest that you work a financial team (financial advisor and/or CPA tax accountant) to come up with a plan to spread your money out for 20 or more years.  Using a $500,000 inheritance example, you can do a withdraw of $50,000 a year, pay tax on this amount and then keep around $20,000.  Put the remaining $30,000 (will be less since you pay taxes) into a combination of savings, IRA, Roth IRA and other mutual funds.  Since you will need to pay tax on the inherited IRA, think of your tax rate when taking out funds.  

There are no taxes on the inherited Roth IRA, therefore, do not take out the Roth IRA until year 9 or 10.  This way the Roth IRA will grow tax free until you take it out. 

I prefer that you save for the future by investing yearly the majority of your inheritance.  However, if you need funds for housing, car, pay off loans, education, etc. you can take out what is needed.  

If you live in a state that has an inheritance tax (i.e. Pennsylvania). Upon receiving a parents investments accounts 401k, (IRA, Roth IRA, 403b, 457b, etc) retirement accounts you will need to pay Pennsylvania inheritance tax of 4.5% on the total amount.   

In addition, once you start withdrawing the funds you will need to pay Federal Income tax (except Roth IRA).  The reason for this is that I did not pay federal tax when the IRA money was deposited into the account.  In addition, depending on the state where you live, you may need to pay state income tax.  For example, PA and FL will have no state income tax on qualified IRA and Roth IRA investments once you start withdrawing. 

You need to withdraw all the funds within 10 years.  Since I would like this money to last you a lifetime, I would like you to withdraw 10% a year.  Of this 10%, keep 40% for spending purposes and put the other 60% into a combination of high yield savings, IRA, Roth IRA and other mutual funds.  If you have no particular funds in mind, check out a Target Fund 2050 and/or 60/40 balance fund.  By balanced fund, I mean a fund that consists of stocks, bonds, both foreign and US.

Key Points

• Inheritance tax to PA 4.5% on total amount received (Note: surviving parent may gift you cash to pay for these Inheritance taxes)

•  Withdraw all the funds within 10 years (new federal tax law) – average 10% each year for the first 10 years. 

•  Do not withdraw from the Roth IRA until the 9th or 10th year.  The reasons for this are that you will not need to pay any taxes on the Roth IRA and it will not count as income on your taxes.  It is best to let the Roth IRA account grow tax free as long as possible.

• During the first 10 years put 60% of what you have withdrawn into a savings account.  Maximize your IRA and/or Roth IRA contributions each year. For example, in 2024 you would put $7000 in your IRA or $7000 in your Roth IRA.  Contribution to Roth IRA may be the best deal if you think that taxes will increase over the years.  Note: If you are working for the government or hospital (nonprofit) you may also be able to contribute an additional $6000 to a 457b.

•  If you need funds for housing, car, pay off loans, etc. you can take out what is needed from the yearly withdraws.

• ·After 10 years, you should have funds in your savings account.  You can start withdrawing from you savings account as needed.  You should continue contributing to your IRA and the moneys that you put into IRA and Roth IRA should not be taken out until you are at least 60 years old.

•  Depending on the situation, you may need to financially help the remaining parent (mom) with long term care expenses.

What should you do if you are a beneficiary and inherits an IRA 

When an adult child inherits an IRA, what they should do depends on a few factors—mainly the type of IRA, whether the original owner had started taking required minimum distributions (RMDs), and whether the child is considered an "eligible designated beneficiary." Here's a breakdown to help:

1. Understand the Type of IRA

• Traditional IRA: Distributions are usually taxable.

• Roth IRA: Distributions are usually tax-free, especially if the account was held for 5+ years.

 
2. Know Your Beneficiary Status

If you are the adult child (not disabled or chronically ill) of the IRA owner, you're a non-eligible designated beneficiary under IRS rules. That means: You must withdraw the entire IRA within 10 years of the original owner's death (per the SECURE Act of 2019).

You can:

• Take withdrawals any time, in any amount, as long as the account is empty by the end of the 10th year after death.

• You’re may be required to take annual RMDs during those 10 years if the original owner was already taking them.

3. Decide How to Take Distributions

You generally have 2 options:

A. Open an Inherited IRA (Best option for most)

• Title it something like: “[Deceased’s Name] for the benefit of [Your Name]”

• You can choose flexible withdrawals over 10 years.

• Allows potential for tax planning (e.g., spread out withdrawals to avoid jumping tax brackets).
  
  

B. Take a Lump Sum (should be avoided)

• You get all the money at once.

• Taxable if Traditional IRA, but not if Roth (assuming it qualifies).

• Could bump you into a higher tax bracket for that year.

4. Plan for Taxes

• Traditional IRA: Distributions count at the federal level as ordinary income.

• Roth IRA: Usually tax-free if it's been open >5 years.  Federal and usually state

• You may want to work with a financial advisor or CPA to plan when and how much to withdraw, especially if you're working or nearing retirement.

5. Avoid Common Mistakes

• Don’t transfer the IRA into your own IRA (only spouses can do that).

• Don’t forget about the 10-year rule.

• Don’t delay setting up the inherited IRA—ideally, do this within a year of the original owner’s death.