Strategies for Reducing Tax Burden on Inherited IRAs

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Quentin Fottrell's MarketWatch column tackles a question that lands in more inboxes every year: what to do with an inherited IRA when the money has a purpose beyond your own retirement. The reader wants to direct a share toward college costs for three children. That single sentence carries a full load of tax consequence, because the SECURE Act of 2019 killed the stretch IRA for most non-spouse beneficiaries and replaced it with a 10-year payout window. The column walks through how a beneficiary can time withdrawals, coordinate them with education expenses, and weigh the tradeoffs against a 529 plan or other vehicles. Fottrell brings in a financial planner's perspective on the order of operations.

For a small-business owner, this is not an abstract estate question. Many owners hold their largest liquid asset inside a traditional IRA or a SEP-IRA, and their children stand to inherit it at the worst possible time: during peak earning years, when every distribution stacks on top of a high marginal rate. If you run a pass-through entity, the added IRA income can push you into a higher bracket, phase out your QBI deduction, or trigger the net investment income tax. The reader's instinct to tie the money to college is sound, because tuition years create a natural offset: you can pull IRA dollars in the same year you claim education credits or deductions, softening the tax hit.

The genuinely contested point here is whether an inherited IRA beats a 529 plan for education funding, and Fottrell's framing deserves scrutiny. A 529 offers tax-free growth and withdrawals for qualified expenses, but contributions come from after-tax dollars and many states cap deductions. An inherited IRA arrives pre-loaded with untaxed earnings, so every dollar out is ordinary income. The planner quoted in the column leans toward exhausting the IRA early in the 10-year window, especially in lower-income years. We agree with that logic, but we would push harder on one omission: if the children are young, the beneficiary cannot wait for their college years to start the clock. The 10-year rule runs from the original owner's death, not from the child's enrollment.

The second-order effects cut in two directions. On one side, pulling IRA money early to pay tuition can preserve the QBI deduction and keep a business owner's taxable income below the threshold where the 20% pass-through benefit phases out. On the other side, large distributions can inflate adjusted gross income enough to reduce financial aid eligibility, because the FAFSA counts untaxed IRA rollovers and can treat the withdrawal as income in the base year. Grandparents and parents who name children as IRA beneficiaries should also know that a minor cannot directly control an inherited account; a custodian or trust must hold it, which adds legal cost and can compress the payout schedule further.

Watch whether Congress revisits the 10-year rule's annual RMD requirement for beneficiaries who inherit after the original owner's required beginning date. The IRS has waived penalties while regulations remain unsettled, but that grace period will end. In the meantime, map your own inherited-IRA strategy now: open the beneficiary account, confirm the December 31 deadline for the first distribution year, and model each withdrawal against your business income, your children's aid packages, and your state tax bracket. If college funding is the goal, run the numbers against a 529 before you touch the IRA. The column gives you the framework; the spreadsheet work is yours.

“I would like to use my share to help fund college for my three children.” — MarketWatch Top Stories

Takeaway: If you inherit an IRA and plan to fund college, coordinate each withdrawal with tuition years, aid rules, and your business income to avoid a stacked tax bill.