How Do I Avoid Paying Taxes on an Inherited IRA?

The standard tax rules on individual retirement accounts (IRAs) change when you’re dealing with inherited IRAs. Some differences are positive. For instance, someone who inherits an IRA doesn’t pay a penalty for early withdrawal before age 59 ½. On the negative side, special rules for inherited IRAs may force beneficiaries to withdraw money sooner than they’d like. That can trigger an unwanted income tax obligation and even push the beneficiary into a higher tax bracket. This would increase the taxes they pay on all income, not just the inheritance. Fortunately, there are ways to avoid or reduce the potential tax liability on an inherited IRA.

A financial advisor can help you manage a large inheritance and develop a plan for taxes, investments, and more.

What Is an IRA?

An individual retirement account, or IRA, is a tax-advantaged investment account designed to help people save for retirement. These accounts allow you to contribute money each year and invest it with the goal of building long-term wealth. They often include assets like stocks, bonds and mutual funds. The key feature of an IRA is its tax treatment. You can either defer taxes until retirement or eliminate taxes on qualified withdrawals altogether. For many people, these benefits make IRAs a central part of their financial planning strategy.

A traditional IRA lets you make tax-deductible contributions to your own retirement savings plan. In addition, earnings from investments made with funds in an IRA grow tax-free. You don’t pay taxes on either contributions or earnings until you start making withdrawals later on after retiring.

A Roth IRA is a retirement savings vehicle that you fund with after-tax dollars. Roth IRA contributions don’t get you a current tax deduction. But earnings on funds in a Roth IRA also grow tax-free. Unlike a traditional IRA, you don’t owe income taxes on qualified withdrawals once you start taking money out in retirement.

Cashing Out an Inherited IRA

An inherited IRA, or beneficiary IRA, is either a traditional or Roth IRA left to you by someone who died. For most individuals, you can cash out an inherited IRA or withdraw at any time. You generally have 10 years from the original owner’s death to cash out the assets in your inherited IRA.

However, there may be some tax consequences of cashing out an inherited IRA. You’ll want to do some tax planning for before you start making withdrawals. Depending on whether you are inheriting a traditional or Roth IRA, the tax consequences could be very different.

Tax Consequences of Inheriting a Traditional IRA

The key point about inheriting a traditional IRA is that taxable amounts you take out are generally taxed as ordinary income. If the amount is large, it could push you into a higher tax bracket, meaning you’ll pay more in taxes on that withdrawal.

Inherited IRAs do qualify for some special treatment, however. For instance, while withdrawals taken by the original account owner before age 59 ½ are ordinarily subject to a 10% penalty, a beneficiary doesn’t have to pay that penalty even when withdrawing at a younger age.

Beyond that, much depends on just who bequeathed you the IRA. If you inherit a traditional IRA from your spouse, you can treat it as your own. This means that you don’t have to take required minimum distributions (RMDs) until you turn 73, or 75 if you were born in 1960 or later. But if you inherit the IRA from someone else, different rules apply. ¹

Most non-spouse beneficiaries must follow the 10-year rule, which means the entire account must be emptied by the end of the 10th year after the original owner’s death. For beneficiaries subject to the 10-year rule, whether annual RMDs are also required during that period depends in part on whether the original owner died before or on or after their required beginning date. If the owner died on or after that date, a non-spouse designated beneficiary generally must take annual distributions during the 10-year period and fully empty the account by the end of year 10. All taxable withdrawals are generally taxed as ordinary income, and large withdrawals could push you into a higher tax bracket.

You can use our income tax calculator to estimate how withdrawals could affect your overall tax bill:

Tax Consequences of Inheriting a Roth IRA

Funds withdrawn from an inherited Roth IRA are generally tax-free if they are considered qualified distributions. That means the funds have been in the account for at least five years. This includes the time the original owner of the account was alive. If the five-year requirement hasn’t been met, distributions of earnings may be taxable. Also, the portion attributable to contributions generally isn’t included in income.

Once again, the relationship between the beneficiary and the original owner makes a difference. A Roth IRA inherited from a spouse can act as the beneficiary’s account. This means the new owner can take tax-free withdrawals once they meet the five-year rule.

If the Roth IRA came from someone other than a spouse, the rules provide a different deadline. Most beneficiaries must fully distribute the account by the end of the 10th year after the original owner’s death. Because a Roth IRA owner is treated as having died before the required beginning date, beneficiaries who are subject solely to the 10-year rule generally do not have to take annual distributions before year 10. Also, the same exceptions for disabled, chronically ill and underage beneficiaries apply.

Tax Planning Strategies for Inherited IRAs

One inherited IRA tax management tip is to avoid immediately withdrawing a single lump sum from the IRA. Instead, wait until RMDs are due, or, if you got the IRA from a non-spouse, stretch withdrawals over 10 years. RMDs are taxable to the extent they consist of taxable traditional IRA funds and can change your tax bracket and increase your overall tax burden. But if, as is often the case, you are in a lower tax bracket when you have to start taking them, you may be able to save on taxes by deferring withdrawals until the RMD rules force you to start.

If you have to empty the account in 10 years, you don’t have to withdraw equal annual amounts. You can instead wait until your income is lower than normal, then take a larger withdrawal from the inherited IRA. Similarly, if your income increases in another year you can take less, as long as you withdraw the entire amount by the end of 10 years. However, annual RMDs may still apply during the 10-year period if the original owner died on or after their required beginning date. This income-leveling strategy can result in a lower overall tax outlay.

Then again, if you inherited the account from a non-spouse who already started taking RMDs, you’ll need to continue taking those RMDs under the applicable beneficiary rules while also satisfying the 10-year deadline if it applies. If you inherited a Roth IRA with funds deposited less than five years ago, one strategy is to wait before taking those funds out. When the five-year period has elapsed, the IRS will treat withdrawals as tax-free qualified distributions.

Roth Conversion

On the flip side, if you want to bequeath your IRA account to a beneficiary, you will have to complete this tax-management strategy before you die. As the account holder, you can convert a traditional IRA to a Roth IRA, thereby paying any taxes due on contributions and earnings.

A Roth conversion may reduce the income taxes a beneficiary ultimately owes on distributions, but whether it lowers the family’s overall tax bill depends on factors including the account owner’s and beneficiary’s tax rates. Additionally, a Roth IRA conversion would then allow your beneficiary to withdraw the funds later on without incurring income taxes once they satisfy the applicable five-year requirement.

Inherited IRAs: Exceptions to the Rule

Not every heir is subject to the standard 10-year rule for draining an inherited IRA. Certain “eligible designated beneficiaries,” including surviving spouses, minor children of the original account owner, individuals with disabilities, chronically ill beneficiaries and those not more than 10 years younger than the decedent, may qualify for exceptions. These beneficiaries can often take required minimum distributions based on their own life expectancy instead of emptying the account within a decade. This extended timeline can reduce taxable income each year and help preserve long-term growth.

A surviving spouse receives the broadest set of tax advantages when inheriting an IRA. They can roll the assets into their own IRA, delay withdrawals until reaching the traditional RMD age or keep the account as an inherited IRA if they need earlier access. Depending on the option selected and the deceased spouse’s age, the spouse may also be able to delay beneficiary distributions until the year the deceased spouse would have reached the applicable required beginning age. This choice allows careful tax planning based on age and income needs, and it may help avoid higher tax brackets in key years. Spousal rollovers remain one of the most powerful exceptions available.

Children and Other Dependents

When a child inherits a parent’s IRA, they qualify for a unique exception but only for a limited period. The child can stretch distributions over their life expectancy until they reach the age of majority, at which point the 10-year rule kicks in. This window allows for smaller annual withdrawals and potentially lower taxes during childhood and adolescence. Families often use this timeframe to plan for education expenses or long-term savings.

Individuals who meet the IRS definitions for disability or chronic illness can avoid the 10-year payout rule while they qualify for life-expectancy distributions as eligible designated beneficiaries. They can instead take distributions over their life expectancy, spreading taxable income across many years. This treatment recognizes that these beneficiaries may rely on the inherited funds for long-term financial support. It also provides significant tax efficiency compared with forced accelerated withdrawals.

Another exception applies to beneficiaries who are not more than 10 years younger than the person who owned the IRA. Because their life expectancies are similar, the IRS allows these heirs to use life-expectancy-based distributions rather than the 10-year schedule. This can soften the annual tax impact and create more consistent income planning. For siblings or long-time partners, this rule can meaningfully extend the value of the inherited account.

Bottom Line

A person who inherits an IRA can face significant tax consequences if they withdraw the money as a lump sum. By stretching withdrawals out over the years they can potentially reduce taxes. This strategy allows them to manage how much taxable income falls into each year. It gives them the opportunity to meet any annual RMDs and track the deadline for emptying the account. A financial advisor can help you find the right choice based on your unique circumstances.

Tips on Saving for Retirement

• If you anticipate inheriting or bequeathing an IRA, you may want to consider working with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you’re planning for retirement on your own, it pays to be in the know. SmartAsset has you covered with tons of free online resources to help. For example, check out SmartAsset’s retirement calculator and get started today.

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