Withdrawn IRA Inheritance and Taxes Debt: What Can I Do?
What happens if you get a traditional IRA, withdraw the money immediately and file your taxes next spring?
He finds out that the IRS wants his cut.
It’s an error that a Reddit user shared in a post explaining their understanding that reporting a $14,000 IRA withdrawal on their tax return means they owe about $2,500 in taxes.
“I went from having a big refund to having less federal and state debt,” a post on r/Tax read. “I didn’t think I would take such a big tax.”
The poster said they earn about $98,000 a year and inherited an IRA from their mother, who died with various debts and no major assets other than a retirement account. When they took out the entire balance of an individual’s retirement account, they chose to withhold 5% in taxes — an amount that proved insufficient.
“I will say that I use free tax software and hate paying for something,” the user added. “But if it means getting help and I don’t owe this much, I would consider it.”
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What you need to know about lump sum distributions from inherited IRAs
Individuals who inherit an IRA generally do not have to pay the standard 10% withdrawal penalty before age 59 1/2. However, if you take a lump sum share, that amount is still taxable as income at the state and federal levels.
Under current federal rules, most non-spousal beneficiaries have a 10-year clock from the time of the account owner’s death to withdraw funds. Spouses and qualified designated beneficiaries may have additional flexibility.
“If they didn’t need to distribute, my recommendation would be to distribute in a few years,” says Julie Hall Labrune, a certified financial planner at Vision Capital Partners in Ann Arbor, Michigan. “Say they were falling into the 12% bracket. That distribution would have bumped them up into the 22% bracket. From 12% to 22% – that’s a big jump.”
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Immediately withdrawing the entire balance of an inherited IRA is not always a tax mistake, and beneficiaries often need the money to pay for a deceased parent’s funeral expenses or their own financial needs. But it’s important to understand the rules and exercise caution. That’s why financial experts recommend mapping out these tax situations in advance.
In this case, setting aside 5% was not enough.
So what? Withdrawals are irreversible, but there are several ways a Redditor can minimize the financial impact on their life. For example, a person could adjust their tax deductions from their regular income to see what tax was due in the previous tax year.
During tax season, that window has closed. But it’s still an option to try to lower your taxable income with last-minute IRA contributions, says Hall Labrune. (For those strategies to work, the taxpayer must fall under the income cutoff.)
A final option would be to consider an IRS payment plan, says Hall Labrune. Given the complexity of this tax issue, it may be better to seek professional advice than to rely on free tax software.
“Go meet the CPA,” said Hall Labrune. “They’re looking at everything, to make sure there’s nothing they can’t do.”
