When we save for retirement, it’s a sad fact that our family or children will sometimes be the ones to enjoy our hard work. It’s common for people to inherit Individual Retirement Accounts (IRAs). It’s important to know the rules about these accounts and how to distribute them so that you don’t end up with extra tax bills and fines after a stressful and emotional time.
Up until now, the Secure Act of 2019 said that recipients of IRAs from 2020 onwards had ten years from the date of the original owner’s death to take out all the money in the account. This made it possible for payments to be spread out fairly over a few years, which fit their lifestyle and helped lower their tax bill. Before that, IRA recipients could spread out their payments throughout their lives. Some beneficiaries can still do that, but most of them have to follow the ten-year rule.
The rules are going to change even more, though. Following the implementation of the SECURE Act 2.0, there will be some major changes in 2025 that will affect how people who inherit retirement accounts handle them.
One of the new changes in the Secure Act 2.0 is meant to clear up any misunderstanding that beneficiaries have had about the withdrawal rules. “You have a multidimensional matrix of outcomes for different inherited IRAs,” says Joel Dickson, global head of advice methodology at Vanguard. It’s hard to keep track of which rules apply to your particular situation.
Changes to who can receive an IRA
Many people thought that the ten-year rule meant that beneficiaries had a maximum of ten years to empty their inherited IRAs. However, the Internal Revenue Service (IRS) had to clarify that most beneficiaries will have to follow required yearly minimum distributions (RMDs) in order to be in line with the ten-year rule.
Beginning in 2025, RMDs will have to be taken every year by people who have to follow the ten-year rule. For people who haven’t done this before, there won’t be any penalties. But from now on, if an annual RMD withdrawal is missed, heirs will have to pay taxes on the amount they should have taken out and also pay a 25% penalty. If the mistake is fixed quickly, this punishment can be lowered to 10%.
There are some inherited IRAs that will not have to follow these RMD exit rules. There are some things that the IRS lets spouses do that let them follow a different set of rules.
The surviving partner can move the money in the account to their own IRA account and follow their schedule if the account holder dies before the start date of their RMDs. The IRS lists these choices as yours:
Because the IRA was left to them as a gift, a spouse can
- Put off starting the payments until the worker turns 72
- Get money based on how long they think they will live
- Do what the 10-year rule says
- Move the money from the account to their own IRA
However, if the account holder dies after the start date of the needed RMD, the spouse beneficiary may:
They can either keep the IRA as an inherited account and take distributions based on how long they plan to live, or they can roll the account over into their own IRA.
“Eligible designated beneficiaries,” such as the spouse or minor child of the deceased account holder, disabled or chronically ill people, and beneficiaries who are no more than 10 years younger than the IRA owner or plan participant, can also get out of the 10-year rule and “take distributions over the longer of their life expectancy and the employee’s remaining life expectancy, or follow the 10-year rule (if the account owner died before that owner’s required beginning date”).
