An inherited individual retirement account could potentially result in a 'tax bomb,' according to an advisor. Here are ways to prevent it.

• Experts advise that if you inherited a pre-tax individual retirement account since 2020, you could face a significant tax bill without proper planning.
• Inherited IRAs must be emptied within 10 years, or waiting could result in increased future withdrawals and tax implications.
• The tax bill increases if you choose not to withdraw from an inherited IRA and it continues to grow, as stated by Carl Holubowich, a certified financial planner and principal at Armstrong, Fleming & Moore.

Experts advise that if you inherited a pre-tax individual retirement account since 2020, you could face a significant tax bill without proper planning.

Inherited IRA withdrawals, commonly referred to as the "stretch IRA," allowed heirs to take distributions over their lifetime previously.

The "10-year rule" in the Secure Act of 2019 mandates that certain heirs, including adult children, must withdraw all funds from inherited IRAs within 10 years of the original account owner's death.

Certified financial planner Ben Smith, founder of Cove Financial Planning in Milwaukee, stated that waiting until the 10th year to make IRA withdrawals could result in a tax bomb.

A surprise tax bill could be the result of a 'back of the napkin math' calculation. 401(k)-to-IRA rollovers have a 'billion-dollar blind spot,' according to Vanguard. Navient student loan borrowers may be eligible for a $120 million settlement.

Withdrawals from pre-tax IRAs are subject to regular income taxes. The 10-year rule can result in higher yearly taxes for certain heirs, particularly for high-earners with larger IRA balances.

Shortening the 10-year withdrawal window can compound the issue, experts say.

Smith stated that larger withdrawals can increase your adjusted gross income, which may result in higher capital gains tax rates or the loss of other tax benefits.

People who take a large inherited IRA withdrawal in a single year may lose eligibility for the electric vehicle tax credit, worth up to $7,500.

Required withdrawals for inherited IRAs

There has been uncertainty since 2019 about whether certain heirs were obligated to make annual withdrawals, referred to as required minimum distributions (RMDs), during the 10-year timeframe.

In July, the IRS finalized the rules for required minimum distributions (RMDs) from inherited individual retirement accounts (IRAs) after years of waived penalties.

In 2025, certain beneficiaries who are not a spouse, minor child, disabled, chronically ill, or certain trusts must begin taking yearly RMDs from inherited IRAs. The RMD rule applies if the original account owner reached their RMD age, or "required beginning date," before death.

The Secure Act raised the required beginning date for RMDs to age 72 from 70½. However, Secure 2.0 enacted two increases: RMDs beginning at age 73 starting in 2023, and age 75 in 2033.

IRA withdrawals are 'a matter of timing'

Experts advise heirs to spread out inherited IRA withdrawals, even if RMDs aren't necessary.

"According to CFP Carl Holubowich, principal at Armstrong, Fleming & Moore in Washington, D.C., if you choose not to withdraw from an inherited IRA in a year and it continues to grow, your tax bill will also increase in proportion. The money in the IRA will eventually be taxed, but the timing of when it will be taxed is uncertain."

Experts suggest that some heirs may opt for larger inherited IRA withdrawals in lower-income years during the 10-year window or explore other tax planning strategies.

Future income tax brackets

Ed Slott, an IRA expert and certified public accountant, previously advised individuals to consider future federal income tax brackets when planning their retirement savings.

If Congress does not act, individual tax provisions, including lower federal income tax brackets, will expire after 2025, resulting in rates of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.

"Each year you miss using [the lower brackets] is a lost chance," Slott stated.

The uncertain control of the White House and Congress makes it challenging to predict if the federal tax brackets will be modified after 2025.