She Inherited $400,000 at 60 and Claimed Social Security at 62. Then Her Tax Bill Went Up.

Retirees often believe that an inheritance won’t affect their Social Security taxes because the money they receive generally isn’t taxed. Income from inherited assets or withdrawals from certain accounts, however, can increase what you report to the IRS and make more of your benefits taxable. An inheritance on its own won’t reduce your monthly Social Security benefit.¹ Here’s how $400,000 could lead to a higher tax bill and what you can do to lower it.

How an Inheritance Might Increase Your Tax Bill

After you receive inherited money or property, any income it generates could be subject to federal income tax. Interest, dividends, realized investment profits and taxable withdrawals from inherited retirement accounts may increase your income. This can also make a larger portion of your Social Security benefits taxable, which means that you would owe taxes on both.

Some of that income is taxable when you receive it, while other amounts aren’t taxed until you sell an investment or withdraw money from an account. The table shows how each type of asset may affect your federal income taxes:

The IRS uses provisional income to determine how much of your Social Security benefits are taxable. This calculation includes adjusted gross income, tax-exempt interest and half of your annual benefits. For a single filer, as much as 50% may be taxed once the total exceeds $25,000, and up to 85% above $34,000.

A withdrawal from an inherited traditional IRA, for example, is usually added to your taxable income for the year. It also raises your provisional income, which could make more of your Social Security benefits taxable.

A financial advisor can help time withdrawals from inherited accounts to limit taxes on Social Security benefits.

How Much Social Security Taxes You May Owe With an Inheritance

If you inherited $400,000 at 60 and are now 62, receive $24,000 annually in Social Security retirement benefits and earn another $15,000 in taxable income, that inheritance could change your tax bill. The amount depends on whether you get cash, withdraw money from an inherited traditional IRA or earn taxable investment income.

The table compares these three situations, assuming you have no tax-exempt interest. Each calculation starts with the same $15,000 in other income and $24,000 in annual retirement benefits:

With the cash inheritance, your taxable income before deductions is $16,000. The inherited IRA withdrawal increases that amount by $59,400, while the investment income raises it by $34,550.

In this example, 85% ($20,400) of the $24,000 benefit is subject to tax. Once that maximum share is reached, earning more would not increase the taxable portion of your benefits. Any additional taxable income would still get taxed on its own, which might raise your overall bill. The $25,000 and $34,000 thresholds also are not adjusted for inflation, so even modest amounts from an inheritance can move you above them.

How the Timing of Inherited Income Can Affect Taxes

The timing of investment sales and IRA withdrawals can change your tax bill. For example, if you withdraw $20,000 annually over two consecutive years instead of a $40,000 lump sum, it could lower your highest single-year income. This may keep you out of a higher federal bracket, but it would also make more of your Social Security benefits taxable over that period. The cheaper option depends on the rates you face in both years.

Your ability to spread out withdrawals depends partly on who left you the IRA. A spouse can often treat an inherited IRA as their own, while most other heirs must empty the account within 10 years. Some might also have required minimum distributions (RMDs) if the original owner died on or after their mandatory beginning date.

Before you decide how much to take in any given year, a financial advisor can help estimate the tax bill for each withdrawal option.

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