The IRS has released its final regulations regarding mandatory withdrawals for inherited retirement accounts. These new rules significantly impact how heirs must manage inherited Individual Retirement Accounts (IRAs) and other retirement plans. If you inherit such an account, understanding these changes is crucial to avoid penalties and minimize tax burdens.
The New 10-Year Withdrawal Rule for Inherited IRAs
Previously, nonspouse beneficiaries could stretch withdrawals over their lifetime, spreading out their tax liabilities. However, the Secure Act of 2019 changed this, requiring most heirs to withdraw the full balance within 10 years of the original account holder’s death.
Who Must Follow the 10-Year Rule?
Most nonspouse beneficiaries fall under this rule, including:
- Adult children inheriting a retirement account
- Family members other than spouses
- Friends or other non-related heirs
- Certain trusts
Who Is Exempt from the 10-Year Rule?
The following groups are not required to follow the 10-year withdrawal rule:
- Surviving spouses
- Minor children (until they reach adulthood)
- Disabled or chronically ill beneficiaries
- Certain trusts
If you are not part of these exempt groups, you must withdraw the full amount from the inherited retirement account within 10 years.
Why Heirs May Pay More Taxes in the Future
Since inherited pre-tax IRAs and retirement accounts are subject to income tax, withdrawing large amounts in a short period can push heirs into higher tax brackets.
Future Tax Rate Increases
As of now, tax rates are relatively low. However, many tax provisions, including lower federal tax brackets, are set to expire after 2025. If Congress does not extend these provisions, tax rates will increase to:
- 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% instead of the current lower rates.
The Best Time to Take Withdrawals
Experts suggest that waiting until the last year of the 10-year period to withdraw everything may result in higher taxes. Instead, strategically withdrawing money over several years when tax rates are still low can save beneficiaries thousands of dollars.
Required Minimum Distributions (RMDs) Begin in 2025
Starting in 2025, some heirs will also be required to take annual minimum withdrawals. These required distributions are only mandatory if the original account holder had already begun their RMDs before passing away.
What Happens If You Miss an RMD?
Failing to withdraw the required amount comes with steep penalties:
- 25% penalty on the amount not withdrawn
- 10% penalty if corrected within two years
To avoid these penalties, heirs must carefully track their RMD obligations and withdraw the correct amount each year.
How to Minimize Taxes on Inherited Retirement Accounts
Here are some strategies to reduce taxes and maximize your inheritance:
1. Spread Out Withdrawals Over Several Years
Instead of taking a lump sum in year 10, withdrawing smaller amounts yearly can help keep you in a lower tax bracket.
2. Withdraw During Low-Income Years
If you expect to retire before the 10-year period ends, wait until you have a lower income to withdraw the funds. This reduces the total tax burden.
3. Consider a Roth IRA Conversion
If the original account owner had a Roth IRA, withdrawals are tax-free. Converting some or all of a traditional IRA into a Roth before inheritance can be a good strategy.
4. Plan for Future Tax Changes
With tax rates expected to rise after 2025, taking withdrawals earlier while taxes are lower might be beneficial.
Final Thoughts
If you have inherited a retirement account, understanding the new IRS rules is essential to avoid penalties and reduce taxes. With the 10-year withdrawal rule now in effect and RMDs required for some heirs starting in 2025, careful planning can help protect your inheritance.
This article has been carefully fact-checked by our editorial team to ensure accuracy and eliminate any misleading information. We are committed to maintaining the highest standards of integrity in our content.
Filza specializes in simplifying financial topics for everyday readers. Whether breaking down Canada’s tax guides or U.S. benefits like SNAP and VA Disability, Filza’s relatable writing style ensures readers feel confident and informed. Follow her insights on LinkedIn or reach out via email at [email protected].