How We Turned a $52,000 Beneficiary IRA into a Tax-Free Retirement Strategy

Introduction: The Power of Strategic Planning

John inherited a $52,000 IRA from his mother at age 47. Like many beneficiaries, he followed the required steps and began taking the required minimum distributions (RMDs). However, he lacked a proactive financial strategy that could better position the potential of his inheritance. This article demonstrates how thoughtful, timely financial planning turned John’s beneficiary IRA into a powerful, tax-free retirement resource.

What Is a Beneficiary IRA?

When you inherit a traditional IRA, it becomes known as a beneficiary IRA or inherited IRA. Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Remember, withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax. Unlike traditional IRAs you open and contribute to during your working years, beneficiary IRAs come with strict rules. Under the SECURE Act , most non-spouse beneficiaries are required to fully distribute the inherited funds within 10 years of the original owner’s death. Additionally, if the deceased had already started taking RMDs, the beneficiary must continue those withdrawals on schedule.

The Consequences of Inaction

Failing to plan around these rules can lead to negative outcomes. Simply taking the minimum distributions without a broader strategy can result in significant taxes, loss of growth potential, and increased financial stress as the 10-year deadline approaches. Without intervention, a large sum may need to be withdrawn in a high-income year, creating an even larger tax liability.

Please consult your financial advisor or tax professional to confirm the rules of an inherited IRA or beneficiary IRA depending on the decedents date of death.

John’s Initial Approach: Minimum Effort, Minimum Return

John’s initial response to inheriting the IRA was to comply with the law, withdrawing $900 to $1,200 annually to satisfy the RMD requirements. However, he didn’t actually need the funds at the time, so they ended up sitting idle in a low-interest savings account or spent. This approach failed to leverage any of the growth potential of the funds, and he missed key opportunities to make that money work more effectively for his long-term retirement goals.

The Problem: A Growing Tax Liability

What John didn’t initially realize was that delaying larger withdrawals could backfire. By taking only the bare minimum, he left a sizable portion of the account untouched. As the 10-year window ticked down, he would eventually be forced to take out large sums, potentially during years with higher personal income. This strategy, or lack thereof, could potentially push him into a higher tax bracket and increase Medicare premiums, eroding much of the inheritance through taxes.

The Game-Changer: Repositioning into a Roth IRA

Our team at Paradigm Wealth Partners helped John see a better path. By using the annual distributions more strategically, he could convert taxable income into tax-free growth.

Step 1: Check Roth IRA Contribution Eligibility

First, we reviewed John’s income to determine his eligibility for direct Roth IRA contributions. In 2025, the IRS limits contributions for single filers starting at $146,000, phasing out completely at $161,000. For married couples filing jointly, the phase-out begins at $230,000 and ends at $240,000. John’s income was well below the threshold, allowing him to make direct Roth contributions. The IRS contribution limits change occasionally and should be reviewed annually.

Step 2: Withdraw More Strategically

Instead of limiting his withdrawal to the annual RMD, we advised John to take a larger distribution of $7,000, which is the maximum IRA contribution limit for 2025 for his age (the maximum IRA contribution limit is higher for those individuals over 50 years old). Although this increased his taxable income for the year, it allowed him to contribute those funds into a more tax-efficient vehicle.

Step 3: Contribute to Roth IRA

The $7,000 withdrawal was moved from the into his checking account, meeting both the withdrawal requirement and freeing the funds for contribution. He then contributed the full amount into a Roth IRA. Once inside the Roth IRA, the funds would be re-invested for tax-free growth, assuming they met the standard 5-year rule.

Step 4: Repeat the Process Annually

John planned to repeat this strategy each year until the beneficiary IRA was depleted. This method would drain the inherited account while systematically funding a Roth IRA, creating a large reservoir of tax-free retirement savings.

Why This Works: Benefits of Roth IRA Conversion Strategy

Tax-Free Growth Potential

Once the funds are inside the Roth IRA, they can be invested and grow without any tax implications. Unlike traditional IRAs, Roth accounts do not require RMDs during the owner’s lifetime, giving John more control over his future income.

Tax-Free Retirement Income

When John eventually retires, he can access the funds from his Roth IRA completely tax-free, provided he has met the age and 5-year holding requirements. This creates a flexible, tax-efficient income stream that won’t impact his Social Security taxation or Medicare premiums.

Tax-Advantaged Legacy Planning

If John doesn’t need the money during retirement, the Roth IRA can be passed on to his heirs. They will also benefit from tax-free withdrawals, giving him assurance that his legacy will be preserved and in a better position for future generations.

The Results: A Stronger Retirement Outlook

By implementing this Roth repositioning strategy, John turned a stagnant asset into a dynamic, tax-free retirement tool. Instead of dreading a large tax bill at the end of the 10-year period, he now enjoys a clear, actionable plan that grows his wealth over time. The strategy provides him flexibility in retirement and shields him from future tax volatility.

Key Takeaways for Beneficiary IRA Holders

Don’t Just Follow the Rules – Plan Around Them

Compliance with minimum distribution rules is essential, but it shouldn’t be the endpoint. A proactive plan can drastically change the financial trajectory of a beneficiary IRA.

Use Roth IRAs to Your Advantage

Redirecting beneficiary IRA distributions into Roth IRAs is a powerful strategy. It turns short-term taxable income into long-term, tax-free growth, unlocking significant retirement and estate planning benefits.

Work with a Financial Advisor

The tax code is complex and always evolving. A seasoned financial professional can help navigate income thresholds, contribution limits, and withdrawal strategies to ensure your money works as hard as you do. Click here to schedule a consultation, get personalized advice, or speak with a financial advisor. Our experienced team at Paradigm Wealth Partners brings decades of financial strategy expertise.

Final Thoughts: Turning Legacy Into Lasting Wealth

John’s story is a testament to the power of strategic planning. With a few informed decisions, he transformed a taxable inheritance into a lasting source of tax-free retirement income. Whether you’ve inherited an IRA or plan to leave one to loved ones, it’s essential to understand the rule. and more importantly, how to use them to your advantage. With professional guidance, a simple inheritance can become a foundational piece of a long-term financial well-being. We’ve helped clients just like John with their retirement. See how personalized planning transformed their futures.

FAQs

1. Can I convert an beneficiary IRA directly to a Roth IRA?
   No. Beneficiary IRAs cannot be directly converted to a Roth IRA. However, you can take distributions and reinvest those funds into a Roth IRA if you are eligible.
2. What happens if I don’t empty an beneficiary IRA within 10 years?
   Failure to fully withdraw the funds may result in a 50% penalty on the remaining balance.
3. Is there an age limit for contributing to a Roth IRA?
   There is no age limit, but you must have earned income and fall within the income thresholds.
4. Does the 5-year Roth rule apply if I fund it with beneficiary IRA withdrawals?
   Yes. Each Roth IRA contribution or conversion must meet the 5-year rule for tax-free withdrawals.
5. Can I use this strategy with larger beneficiary IRAs?
   Yes, but you may need more complex tax planning.

 

 

Disclaimer

This is a hypothetical situation based on real life examples. Names and circumstances have been changed. The opinions voiced in this material are for general information only and are not intended to provide specific individualized investment, tax or legal advice for any individual. We suggest that you discuss your specific situation with a qualified, legal advisor and financial advisor. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal.