Managing Inherited IRAs for Young Children: Tax Implications & Withdrawal Strategy

Does the kiddie tax apply even if the money stays within the inherited IRA? Or only when distributions are taken? Also, would it be better to withdraw more early on while they have no other income, or wait until later in the 10-year period when the money has had more time to grow?

The kiddie tax only applies to distributions taken from the inherited IRA, not to money that remains invested within the account. As long as the funds stay within the inherited IRA, there are no tax consequences. Regarding timing, there's definitely merit to taking strategic distributions during their lower-income years. However, there's also value in letting the investments grow tax-deferred for longer. A balanced approach might be best - perhaps taking smaller distributions in the early years to take advantage of their standard deductions and lowest tax brackets, then increasing the distributions in later years. This spreads out the tax burden while still allowing most of the money to grow tax-deferred for a longer period.

How exactly does this work? Do you upload documents to them and they analyze? I'm in a similar situation with my niece inheriting an IRA and honestly the paperwork from the financial institution is confusing me.

Sounds interesting but I'm always skeptical of these services. How accurate was their advice compared to what an actual CPA would tell you? And did they help with the actual tax filing or just give you information?

You upload your documents to their secure system and their AI analyzes them. They have specific expertise with inherited retirement accounts, so they can spot issues that might be missed otherwise. The system flags important deadlines and requirements specific to your situation. Their advice matched what my CPA eventually told me, but they provided it much faster and with more detail about the specific IRS regulations that applied to my situation. They don't actually file your taxes for you, but they give you detailed guidance on how to complete the forms correctly and what supporting documentation you'll need. In my case, they also created a multi-year distribution plan that showed the tax implications of different withdrawal strategies.

How does this actually work? I've spent literal hours on hold with the IRS trying to get guidance on an inherited IRA. Does this really get you through faster?

Come on, this sounds too good to be true. The IRS phone system is notoriously terrible. How could a third-party service possibly get you to the front of the line? Are they using some kind of loophole that might get you in trouble?

It uses a combination of technology and their call system to navigate the IRS phone tree and secure your place in line. When an agent becomes available, they connect you directly to that person. It saved me about 2 hours of hold time based on what the IRS recording was saying when I first called. No, it's not a loophole that gets you in trouble. They're just efficiently navigating the system and holding your place in line. The IRS representatives have no idea you've used a service - you're just a caller who's reached them through the normal channels, but without the painful wait. Think of it like having someone physically wait in line for you.

Could you explain more about the trust option? I'm in a similar situation but worried about my kid getting full control at 18 or 21. Would a trust let me extend that to an older age?

Absolutely. Unlike UTMA/UGMA accounts where the child typically gains control at age 18 or 21 (depending on state law), a trust allows you to set specific ages or milestones for distributions. For example, you could structure it so they receive portions at different ages (25, 30, 35) or tie distributions to events like completing college or buying a first home. A properly structured trust can also provide additional asset protection and potentially some tax planning benefits depending on your specific situation. The downside is that there are costs to establish and maintain a trust, so you'll need to weigh those against the benefits. I'd recommend consulting with an estate planning attorney who has experience with inherited IRAs to explore this option further.

Yes, as the custodian you generally have the ability to direct the investments within the inherited IRA. You're right to consider a longer-term strategy given her age. I rebalanced my nephew's inherited IRA to be much more growth-oriented since he won't need the money for decades. Just make sure you're making changes within the inherited IRA account and not triggering a distribution by moving money out of it.

This is really helpful advice about the FAFSA implications - I hadn't thought about that! For the Roth conversion idea, would that still be subject to the kiddie tax rules? And if we do convert portions during their low-income years, does that reset the 10-year withdrawal timeline or does the original 10-year rule still apply to the converted amounts? Also, regarding the tax law changes you mentioned - are there any specific proposals we should be keeping an eye on that might affect inherited IRA distributions? I want to make sure our strategy remains flexible enough to adapt to potential changes.

@407e984dc284 Great questions! For Roth conversions, yes, the kiddie tax rules would still apply to the conversion amounts since they're treated as taxable income. However, given their likely low overall income, you might still come out ahead even with kiddie tax considerations. Regarding the 10-year rule - this is crucial to understand. Once you convert from a traditional inherited IRA to a Roth inherited IRA, the original 10-year timeline continues to apply. The conversion doesn't reset the clock. So if you're in year 3 of the original 10-year period, you'd still have 7 years remaining to fully distribute the Roth inherited IRA. For tax law changes to watch, the big one is the expiration of the Tax Cuts and Jobs Act provisions in 2025, which will likely mean higher tax rates and potentially different bracket structures. There's also ongoing discussion about changing retirement account rules, though inherited IRAs seem less likely to see major changes than other areas. I'd recommend staying flexible and reassessing your strategy annually based on any legislative developments. The FAFSA timing strategy could be particularly valuable - maybe front-load some distributions in their early teens, then minimize distributions during junior/senior year of high school and first few years of college.