Managing an inherited Individual Retirement Account (IRA) comes with complex rules that, if not properly followed, can lead to significant tax penalties. With the SECURE Act 2.0 set to take effect in 2025, beneficiaries of IRAs should familiarize themselves with the new changes to avoid complications during what is often an emotional and challenging time.
The Current Landscape: The 10-Year Rule
Under the SECURE Act of 2019, most beneficiaries of IRAs inherited from 2020 onward must withdraw the entire account balance within 10 years of the original owner’s death. This replaced the previous rule allowing beneficiaries to stretch distributions over their lifetime.
This change allowed beneficiaries to manage withdrawals flexibly, spreading them across the 10-year window to minimize tax burdens. However, confusion arose regarding whether annual withdrawals were required, leading to clarifications from the Internal Revenue Service (IRS).
What’s Changing in 2025?
The SECURE Act 2.0 introduces required minimum distributions (RMDs) for beneficiaries subject to the 10-year rule:
- RMDs Begin in 2025: Beneficiaries must withdraw a portion of the inherited IRA annually.
- Penalties for Missed RMDs: If an RMD is missed, beneficiaries will face a 25% penalty on the required withdrawal amount, which can be reduced to 10% if corrected promptly.
- Exceptions for Certain Beneficiaries: Spouses, minor children, disabled or chronically ill individuals, and those within 10 years of the original account holder’s age may qualify for exemptions or different rules.
Options for Spouses
Surviving spouses have several options to manage an inherited IRA, depending on when the original account holder passed away:
- If the account holder died before their RMD start date:
- Delay distributions until the account holder has turned 72.
- Take distributions based on their life expectancy.
- Follow the 10-year rule.
- Roll over the account into their own IRA.
- If the account holder died after their RMD start date:
- Keep the inherited IRA and take distributions based on their life expectancy.
- Roll over the account into their own IRA.
Exceptions for Eligible Designated Beneficiaries
Certain beneficiaries, known as “eligible designated beneficiaries,” may bypass the 10-year rule. These include:
- Minor children of the deceased (until they reach adulthood).
- Disabled or chronically ill individuals.
- Beneficiaries no more than 10 years younger than the account holder.
These individuals can take distributions based on the longer of their life expectancy or the remaining life expectancy of the deceased.
Why It Matters
Failing to adhere to the new rules could result in significant financial penalties, adding stress to an already emotional situation. Beneficiaries should review their options, understand their obligations, and consult with financial advisors to ensure compliance.
By staying informed, beneficiaries can manage inherited IRAs effectively and minimize tax burdens, preserving more of the funds for their intended purpose.
