First, thank your lucky stars for a generous Grandpa who spent less than he saved. He’s a financial role model who’s given you the gift of an extra boost.
Can I just leave it to grow?
Let’s assume this is a Traditional IRA (not a Roth, which has different rules and was less common in Grandpa’s day).
If you don’t need the money right away, you might think you can just leave it in the account and let it grow tax free. But you can’t. The government wants you to pay taxes on that money, not hoard it. You’re required to drain the account – and pay taxes on it — within 10 years of his death. So if Grandpa died in 2024, his account must be empty no later than December 31, 2034.
If Grandpa was older than 70-1/2 (a strange age, but that’s the government’s rule) he was required to take “Required Minimum Distributions” (RMDs) each year from his Traditional IRA account. Why? Because Uncle Sam is tired of waiting for tax revenue. At age 70-1/2, he had to stop hoarding and start paying taxes on a minimum amount each year. Now, you have to withdraw a minimum and pay taxes on it. (If this is a Roth IRA, there are different rules because with a Roth, taxes were paid before they were contributed.)
How do I figure out the Required Minimum Distribution?
It will change each year based on 1) the balance of the IRA account as of December 31 of the prior year, and 2) your life expectancy. The easiest way to figure out the RMD is to ask the bank or brokerage firm to calculate it for you. Or use an online calculator like this one:
Schwab RMD calculator for inherited IRAs
It’s important to make these RMDs every year, because the penalty for not taking them is stiff: up to 25% of the amount you should have withdrawn.
How should I withdraw money?
There are several options depending on your financial situation.
- Take it all out in one lump sum, which means taking a big tax hit in one year. The IRA money will be taxed as “ordinary income,” which is like getting a supersized paycheck. Add that to your other income earned in a year and it can push you into a higher tax bracket — which means you’ll pay more taxes on the rest of your income, too. Still, it might make sense to do that if you’re earning less now than you think you will in future years. Pay the tax bill while you’re in a lower tax bracket. This might especially make sense if you’ve been laid off, you’re working part time or gig jobs, or you’re considering moving to a state with higher state tax rates.
- Withdraw payments every year for 10 years. This is a simple way to make sure the account is empty by the 10th year. You’ll want to make sure you’re taking out at least the Required Minimum Distribution each year. You can withdraw equal payments every year, or be more flexible, withdrawing more in years when the market is down and less when the market is up, which may reduce the taxes due over all.
- Withdraw the Required Minimum Distribution for 9 years and drain the rest in year 10. This is the way to postpone taxes for as long as possible. You might consider that if you’re in a high tax bracket right now, but expect it to drop in the next decade. Or you live in a high tax state but are moving to a state with lower taxes. Keep in mind, waiting until year 10 may result in a large tax bill that year if the account has grown significantly.
Can I move the money into my own IRA?
Because this is a Traditional IRA with special tax rules, best to leave it in its own separate account. If you consider this to be future retirement savings for yourself, you could take your withdrawals from Grandpa’s IRA (either all at once or over the 10 years), pay taxes, and then deposit them into your own Roth IRA. That way, the growth in your account – and possibly future distributions from it – will be tax-free.
Your next steps
- Ask the bank or brokerage firm whether your inherited IRA is a Traditional or Roth account. There are different rules for each.
- Ask them to calculate the Required Minimum Distribution and have it direct deposited into one of your accounts — a Roth IRA, savings or checking account. The first RMD may be due in the year your Grandpa died, if he didn’t take it.
- Set an annual reminder on your phone to calculate and withdraw the RMD each year before December 31.
- Thank your lucky stars for your generous Grandpa.