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There has been a change to inherited individual retirement account rules which mandates that certain heirs must take required withdrawals each year or face an IRS penalty.
Starting in 2025, certain beneficiaries must take annual required minimum distributions while depleting inherited IRAs over 10 years, according to final regulations released in July.
The “10-year rule” and RMD requirement applies to most non-spouse heirs — commonly, adult children — if the original IRA owner reached RMD age before their death.
Meanwhile, the average investor doesn’t know a great deal about these guidelines, said certified financial planner and enrolled agent Catherine Valega, founder of Green Bee Advisory in the Boston area.
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Despite the change, beneficiaries should weigh strategic IRA withdrawals, depending on tax brackets each year, which could mean emptying accounts sooner, experts say.
Here’s what to know about the change for inherited IRAs.
Who could face an IRS penalty
There’s been widespread confusion about which heirs need to take RMDs from inherited IRAs, according to IRA expert Denise Appleby, CEO of Appleby Retirement Consulting in Grayson, Georgia.
Since 2020, the 10-year rule has applied to heirs who are not a spouse, minor child, disabled, chronically ill or certain trusts. However, until the IRS issued its regulations last year, it’s been unclear whether yearly RMDs were required during the 10-year drawdown.
If the original owner reached RMD age before death, beneficiaries also must take RMDs, Appleby said.
Previously, the IRS waived penalties for missed RMDs on inherited IRAs. But if you don’t start yearly RMDs in 2025, you could be subject to a 25% penalty on the amount you should have withdrawn.
The IRS could reduce the fee to 10% if you withdraw the proper amount within two years and file Form 5329. In some cases, the agency will waive the penalty entirely.
“A lot of clients are getting that excise tax waived” by correcting the RMD, filling out the form and providing a “reasonable explanation,” Appleby said.
Why it could pay to take the money sooner
While penalties will apply for missed RMDs in 2025, some heirs should start emptying inherited accounts sooner, experts say.
Over the past few years, some heirs have skipped yearly withdrawals from inherited IRAs, which could mean larger RMDs before the 10-year window ends. Pre-tax withdrawals are subject to regular income taxes.
“The quicker you do it, the better it is,” said CFP Scott Bishop, partner and managing director of Presidio Wealth Partners, based in Houston. “It’s better to start clipping that away earlier.”
Typically, advisors project taxes over multiple years and take IRA withdrawals during lower-income years.
