Inheriting an IRA? Why You May Not Want to Withdraw All the Money at Once.

When loved ones pass away, their unspent retirement savings don't disappear. They go to whomever the benefactors chose as beneficiaries -- often their spouse or children, but sometimes other family members or friends, too.

If you recently inherited an IRA, you might be tempted to put all that money to good use right away. But there's a hidden downside to doing that.

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The problem with withdrawing all your inherited IRA funds at once

There's no rule forbidding you from withdrawing every penny from your inherited IRA as soon as you get your hands on it. That's within your rights. It just might not be in your best interest.

If the money comes from a traditional IRA, the original owners didn't pay taxes on it. The government gave them a tax break in the year they made their contributions. So now, when you take the money out, you owe the government taxes on those funds as if they were income you had earned from a job.

For example, if you received $100,000 in your inherited IRA and you took it out all at once, the government will treat you as if you earned $100,000 more from your job that year. That's almost certainly going to bump you up a tax bracket or two, and it could lead to a surprise bill later. If you have already spent all your inheritance on other things, that could leave you in a tight spot.

You don't have to worry about this problem if you're inheriting a Roth IRA. The original owner paid taxes on the contributions, so you can take withdrawals tax-free. However, if you take the money out all at once, you miss out on the potential investment earnings you could have had if you had left that money alone for a few more years.

What you can do instead

The IRS sets strict limits on what you can do with inherited IRAs. For example, only the original owner's spouse can roll an inherited IRA over into the survivor's own IRA. This could be the right move if you don't need the money for a while and you don't want to be forced to take it out until your own retirement.

Non-spousal beneficiaries typically must follow the 10-year rule. This says you can take withdrawals whenever you would like, but you must withdraw everything from the inherited IRA by the end of the 10th year after the year the account owner died.

In this case, it's often better to spread your withdrawals out over the 10-year time frame. This minimizes the tax impact in any given year for a traditional IRA and lets a portion of the investments continue to grow for another decade.

It's ultimately up to you, though. It's fine to withdraw a large chunk initially if that's what you want. Just ensure you're comfortable with the tax implications.

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