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Maximizing Inherited Value and Minimizing Taxes

Beneficiaries who inherit traditional IRAs and 401(k)s must pay income taxes on the distributions just as the original owner would have. Beneficiaries really inherit only the after-tax value of retirement accounts, and that value depends on the beneficiary’s tax bracket.

Remember that the original SECURE Act enacted in 2019 eliminated the Stretch IRA. Beneficiaries no longer can spread distributions from an inherited retirement account over their life expectancies. Instead, most beneficiaries must distribute the entire IRA within 10 years.

The SECURE Act’s distribution rules generally increase the taxes paid on the inherited IRA, because the distributions are bunched into fewer years. The SECURE Act also eliminates the long-term benefits of an IRA’s tax-deferred compounding. When the IRA owner delays and minimizes distributions, it’s likely that higher taxes will be transferred to beneficiaries.

Don’t let Congress and the IRS determine your IRA distribution strategy. Consider the income taxes both you and your heirs will pay on retirement account distributions. Compare the lifetime taxes that would be paid by you and your family under different scenarios and decide on the optimum strategy.

You need to run all the numbers from different scenarios and examine the results over a long time. The best analysis covers not only the rest of your life but also after your beneficiaries inherit.

There are software programs available to help, and of course you can work with a financial planner.

Many studies and projections by me and other analysts reached the same conclusion over the years. It often makes sense to begin spending from IRAs and other traditional retirement accounts earlier than required in order to defer claiming Social Security benefits. It’s also a good idea for many people to begin spending from traditional IRAs before being forced to take RMDs.

If you don’t claim Social Security benefits until 70, you have an extended period during which you will have no earned income and will be in relatively low tax brackets. You essentially can pick your tax brackets by choosing how to take income from the different accounts you own.

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