I Cashed Out an Inherited IRA and Owe Taxes: What Can I Do?

Inheriting a traditional IRA can come with unexpected tax consequences, as one Reddit user recently discovered. After cashing out a $14,000 IRA and reporting it on their tax return, they found themselves facing a tax bill of around $2,500. This mistake serves as a cautionary tale for those who may not fully understand the tax implications of inherited IRAs.

The Reddit user, who earns $98,000 per year, inherited the IRA from their mother, who passed away leaving behind debts and no major assets besides the retirement account. Opting to cash out the entire balance of the IRA and only withhold 5% for taxes proved to be a costly error.

While non-spouse beneficiaries typically do not have to pay the standard 10% penalty for early withdrawals from an inherited IRA, the money is still subject to income tax at the federal and state levels. Most beneficiaries have a 10-year window to withdraw the funds, but failing to plan for the tax implications can lead to a significant tax hit.

Financial professionals recommend spreading out distributions over several years to avoid jumping into a higher tax bracket. In this case, withdrawing the entire balance in one lump sum resulted in a larger tax bill than anticipated.

Moving forward, the Reddit user may consider adjusting their tax withholding from their regular earnings to offset the tax burden. Making last-minute IRA contributions could also help lower taxable income, but seeking professional advice from a CPA is recommended given the complexity of the situation.

Ultimately, inheriting an IRA requires careful planning and understanding of the tax implications involved. By taking proactive steps to manage taxes and seek professional guidance, beneficiaries can minimize the financial impact of inheriting an IRA.