If you’ve postponed taking required distributions from an inherited IRA, mark your calendar. There’s a good chance you’ll need to start taking withdrawals from your account next year to avoid a hefty penalty from the IRS.
Beneficiaries of traditional IRAs have always had to pay taxes on withdrawals from inherited accounts, but before 2020, they could minimize the tax bill by extending withdrawals over their life expectancy. The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was signed into law in 2019, put an end to this tax-saving strategy for most adult children, grandchildren and other non-spouse heirs who inherit a traditional IRA from someone who died on or after January 1, 2020.
Those heirs now have two options: Take a lump sum and pay taxes on the entire amount or transfer the money to an inherited IRA that must be depleted within 10 years after the death of the original owner. For example, if you inherited an IRA in 2020, year one is 2021, and the account needs to be cleaned out by December 31, 2030.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Inherited IRA rules clarified
Initially, tax experts believed non-spouse beneficiaries could wait until year 10 to deplete their accounts, which would give beneficiaries more flexibility in how they time their withdrawals.
But the IRS issued guidance in early 2022 stating that if the original owner died on or after the date he or she was to take required minimum distributions, non-spouse beneficiaries must take RMDs based on their life expectancy in years one through nine and deplete the balance in year 10. (If the original owner hadn’t started RMDs, beneficiaries can take withdrawals anytime during the 10-year period.)
In response to confusion about that guidance, the IRS waived penalties for failing to take an RMD from an inherited IRA in tax years 2021 through 2024. However, the IRS issued final inherited IRA rules in July stating that beneficiaries must start taking RMDs next year and deplete the account within 10 years of the original owner’s death. The penalty for missing a distribution is 25% of the amount you should have withdrawn. (The penalty will be reduced to 10% if you make up the missed RMD within two years.)
Inherited Roth IRAs
The 10-year rule also applies to inherited Roth IRAs, but with an important difference: You aren’t required to pay taxes on the withdrawals, and you don’t have to take required minimum distributions because the original owner didn’t have to take them, either.
If you can afford to wait until year 10 to deplete the account, you’ll enjoy more than a decade of tax-free growth.
Inherited IRA rules for spouses
The 10-year rule doesn’t apply to spouses who inherit an IRA. They’ll continue to have the option of rolling the money into a new or existing IRA and postponing withdrawals until they reach the age at which they must take RMDs (currently age 73).
Still, the requirement will affect millions of Generation X, millennial and Gen Z adult children who stand to inherit trillions of dollars in IRAs and other assets from their parents over the next 20 years.
Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.
Related Content
-
When Does a Nest Egg Become a Ticking Tax Bomb?Retirement savers with big bucks in traditional IRAs and pretax 401(k)s could face huge tax bills when RMDs kick in. One potential solution? A Roth 401(k).
-
Medicare or Medicare Advantage: Which Is Right for You?From overall costs to availability of care, here's what to know about the differences between traditional Medicare and Medicare Advantage plans.
-
When Does a Nest Egg Become a Ticking Tax Bomb?
Retirement savers with big bucks in traditional IRAs and pretax 401(k)s could face huge tax bills when RMDs kick in. One potential solution? A Roth 401(k).
-
Medicare or Medicare Advantage: Which Is Right for You?
From overall costs to availability of care, here's what to know about the differences between traditional Medicare and Medicare Advantage plans.
-
Wealth Is More Than Just Your Money: How to Manage It AllIn addition to handling your financial wealth, consider ways to manage your non-financial assets: health, knowledge, time and relationships.
-
You're 60 Years Old With $1 Million Saved: Can You Retire?The answer depends on several factors. The key is to create a plan that combines all aspects of retirement — income, taxes, health care and legacy planning.
-
Social Security Tax Limit Jumps 4.4% for 2025Social Security The Social Security Administration has announced significant changes affecting millions as we approach a new year.
-
Social Security COLA Is 2.5% for 2025: What to KnowThe 2025 Social Security COLA, tax wage cap and how much you need to earn to qualify for SS credits has been announced by the Social Security Administration.
-
Come as You Are: Wealth Management for Gen XGen X is stuck in the middle of kids and aging parents, but retirement's not far off. Time to prioritize, with help from Nirvana, The Eagles and David Bowie.
-
How to Create a Retirement Plan That Checks All Your BoxesYou might consider starting with a model retirement plan that has already been assembled and is ready to be refined to meet your objectives.
