You are about to inherit right when you retired

You are about to inherit right when you retire. Here is why that is a tax problem.

If you are in your late fifties or early sixties, there is a good chance you are managing two financial transitions at once. You are getting ready to retire, and your parents are in their eighties. Which means at some point in these same years, you may inherit. That timing feels like it should be a good thing, and in most ways it is. But an inheritance that lands in the middle of your early retirement can quietly push your taxes up for a decade, and almost nobody sees it coming until it has already happened.

A note before we start, because it matters for anything you read on this topic. The rules governing inherited retirement accounts have changed more than once in recent years, and the guidance around them has been revised several times as well. A lot of what is still floating around online describes the old rules and is simply wrong now. This piece reflects the current landscape, but because this is an area that keeps moving, the single most important thing is to confirm the current rule for your situation rather than trusting an old article, including this one if enough time has passed.

The collision

In the last piece, we talked about the gap years, the low-income window in early retirement where you deliberately fill your low tax brackets, the Tax Bracket Stuffing years. That plan depends on one thing: your income staying low during those years.

Now picture an inheritance arriving in the middle of that window, specifically a traditional IRA or 401(k) inherited from a parent. That is where the problem starts.

What changed, and why it lands on your tax bracket

It used to be that when you inherited a retirement account from a parent, you could stretch the withdrawals over your own lifetime, taking a little out each year and spreading the tax over decades. That was the stretch IRA, and it was gentle on your taxes.

That changed with the SECURE Act, and the details have been adjusted more than once since. In most cases now, a non-spouse who inherits a traditional retirement account has to empty it within ten years. Ten years, not a lifetime. Every dollar that comes out of that inherited traditional account is taxable income to you, and you have a limited window to take it all out.

Here is the collision, and it is all about your tax bracket. You are in your early sixties, retired, with your income deliberately low. Then you inherit a large traditional IRA that you now have to drain over ten years, and every withdrawal stacks on top of your own income. Those years you were counting on being low-income years are suddenly not, because the inherited account is pouring taxable income on top of everything else. The low brackets you were sitting in get filled, then overflow into higher ones, and because the ten-year window often overlaps your own highest-earning retirement years, a lot of that inherited money can come out taxed at rates far higher than the original owner ever paid on it.

That is the heart of the problem. It is not that inheriting is bad. It is that a traditional inherited account is a stream of forced taxable income landing in exactly the years your bracket was supposed to be low, and if you drain it without a plan, you hand a large share of it to taxes that a little sequencing could have avoided.

The part that shows up two years later: IRMAA

There is a second cost, and it is the one almost nobody connects to an inheritance until the bill arrives.

Once you are on Medicare, what you pay for it is not the same for everyone. Higher earners pay a surcharge on their Medicare premiums, and that surcharge, called IRMAA, is based on your income from two years earlier. That two-year lookback is the trap. A big inherited-IRA withdrawal you take at 63, to satisfy the ten-year rule, can quietly raise your Medicare premiums at 65. The withdrawal and the surcharge do not even happen in the same year, which is exactly why people never see the connection.

So the inherited account does not just raise your income tax in the year you take the money. It can reach forward two years and raise what you pay for Medicare too. One inheritance, drained without a plan, can push up your income tax bracket now and your Medicare surcharge later, from the same withdrawals.

Why this is the clearest case of the whole point

This is the sharpest example in this entire series of why these decisions cannot be handled one at a time. Nobody plans their parent's passing, and nobody controls when it happens. It is an event that arrives from outside your plan and lands in the middle of it, and it changes the math on almost everything, your tax bracket, your withdrawal sequencing, and your Medicare surcharge two years down the line.

The person managing their own retirement in isolation does not see it. The person who inherits and just starts taking the required withdrawals, spreading them evenly or waiting until the end of the ten years, without looking at the rest of their plan, can end up paying far more tax and higher Medicare premiums than they had to, simply because the pieces were never looked at together. The value is not in handling the inheritance well or the retirement well. It is in seeing that they are now the same plan, and pacing the whole thing on purpose.

What to do

If you know an inheritance is likely in your retirement years, it is worth planning for before it arrives, not after. The core of the work is pacing the ten-year drawdown deliberately, taking more in your genuinely lower-income years and less in the years a big withdrawal would spike your bracket or trip an IRMAA surcharge, rather than draining it evenly or all at once. It can also mean coordinating with your parents' own planning while there is still time, because some of this is far easier to manage before the accounts change hands than after.

This is planning that spans two generations and several moving parts at once, and it is exactly the kind of thing that benefits from a coordinated view, working with your accountant on the tax side and, where the estate is complex, with the attorney handling your parents' plan. Because the rules here have moved several times and still carry nuance, the current details genuinely need to be confirmed for your situation rather than assumed. What does not change is the shape of the problem: an inheritance landing in your early retirement years is not just a windfall, it is a stream of forced income that lands on your tax bracket now and can reach your Medicare premiums later, and it rewards being seen coming.

If you expect to inherit in the years around your retirement and want to plan for it before it lands rather than react to it after, that is exactly the kind of thing worth mapping while there is still room to act. Start a conversation.

DISCLOSURES:

Riverstone Wealth Partners and LPL Financial do not provide legal or tax advice. Please consult with your tax or legal advisor regarding your personal situation.
 

This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation.