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 The penalty for missing a distribution is 25% of the amount you should have withdrawn.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
-
Cord Cutting Could Help You Save Over $10,000 in 10 YearsHow cutting the cord can save you money and how those savings can grow over time.
-
The '8-Year Rule of Social Security' — A Retirement RuleThe '8-Year Rule of Social Security' holds that it's best to be like Ike — Eisenhower, that is. The five-star General knew a thing or two about good timing.
-
The '8-Year Rule of Social Security' — A Retirement Rule
The '8-Year Rule of Social Security' holds that it's best to be like Ike — Eisenhower, that is. The five-star General knew a thing or two about good timing.
-
Tips for Expat Retirees, From Expat RetireesYou may enjoy a lower cost of living by moving abroad, but it requires careful planning.
-
You Were Planning to Retire This Year: Should You Go Ahead?If the economic climate is making you doubt whether you should retire this year, these three questions will help you make up your mind.
-
Are You Owed Money Thanks to the SSFA? You Might Need to Do Something to Get ItThe Social Security Fairness Act removed restrictions on benefits for people with government pensions. If you're one of them, don't leave money on the table. Here's how you can be proactive in claiming what you're due.
-
From Wills to Wishes: An Expert Guide to Your Estate Planning PlaybookConsider supplementing your traditional legal documents with this essential road map to guide your loved ones through the emotional and logistical details that will follow your loss.
-
Why Retirees Need a Budget, According to a New RetireeA new retiree explains why retirees need a budget.
-
Hiring a Financial Adviser: 10 Questions to AskWhen hiring a financial adviser, ask these 10 questions to weed out the duds and find the right person to manage your nest egg. After all, you're the boss.
-
Your Home + Your IRA = Your Long-Term Care SolutionIf you're worried that long-term care costs will drain your retirement savings, consider a personalized retirement plan that could solve your problem.
