Navigating Inherited IRAs: Understanding the New Rules Effective 2025

Matthew Delaney
14 minutes ago
3 min read

Inheriting an Individual Retirement Account (IRA) can significantly impact your financial planning. Recent changes introduced by the SECURE Act of 2019 and further clarified by the SECURE 2.0 Act have redefined the rules governing inherited IRAs. The Internal Revenue Service (IRS) finalized these regulations in July 2024, and they are set to take effect in 2025. Understanding these changes is crucial for beneficiaries to manage their inheritance effectively and avoid potential tax pitfalls.

Failure to Launch: Getting Your Adult Child to Move Out

The 10-Year Rule: A Shift from the Stretch IRA

Previously, non-spouse beneficiaries of inherited IRAs could "stretch" distributions over their lifetime, allowing for prolonged tax-deferred growth. However, the SECURE Act of 2019 introduced the "10-year rule," requiring most non-spouse beneficiaries to fully deplete the inherited IRA within ten years of the original owner's death. This change aimed to accelerate tax revenue collection and simplify the distribution process.

The IRS's final regulations, issued in July 2024, reaffirm this 10-year distribution requirement. Beneficiaries must ensure the entire account balance is withdrawn by the end of the tenth year following the original owner's death. Failure to comply can result in significant tax penalties.

Annual Required Minimum Distributions (RMDs) Within the 10-Year Period

A point of confusion addressed by the IRS's 2024 guidance is whether beneficiaries must take annual RMDs during the 10-year period. The final regulations clarify that if the original IRA owner had already begun taking RMDs before their death, the non-spouse beneficiary is required to continue taking annual RMDs during the 10-year period.

This means that for deaths occurring in 2020 or later, if the decedent had reached their required beginning date for RMDs, the beneficiary must take annual distributions for years one through nine and fully distribute the account by year ten.

Exceptions to the 10-Year Rule

Certain beneficiaries are exempt from the 10-year rule and can still stretch distributions over their lifetime. These "eligible designated beneficiaries"

Surviving spouses: They have the option to treat the inherited IRA as their own or take distributions over their life expectancy.
Minor children of the account owner: They can stretch distributions until they reach the age of majority, after which the 10-year rule applies.
Disabled or chronically ill individuals: They can take distributions over their life expectancy.
Individuals not more than ten years younger than the decedent: They can also stretch distributions over their life expectancy.

It's important to note that these exceptions are narrowly defined, and most non-spouse beneficiaries will be subject to the 10-year rule.

Impact on Roth IRAs

The 10-year rule also applies to inherited Roth IRAs. However, since Roth IRAs are funded with after-tax dollars, distributions are generally tax-free, provided the account has been open for at least five years. Importantly, for inherited Roth IRAs, beneficiaries are not required to take annual RMDs during the 10-year period, regardless of whether the original owner had begun distributions.

Temporary Relief for Missed RMDs

Recognizing the confusion surrounding the new rules, the IRS has provided temporary relief for beneficiaries who may have missed RMDs in 2021 through 2024. Specifically, the IRS has waived penalties for missed RMDs during these years. However, starting in 2025, beneficiaries must comply with the annual RMD requirements if applicable, and failure to do so may result in penalties.

Tax Implications and Planning Strategies

The accelerated distribution timeline can lead to higher taxable income during the 10-year period, potentially pushing beneficiaries into higher tax brackets. To mitigate this, beneficiaries might consider strategies such as:

Spreading distributions: Taking distributions evenly over the 10 years to manage taxable income.
Roth conversions: If eligible, converting traditional IRA assets to a Roth IRA before inheritance can provide tax-free distributions for beneficiaries.
Charitable giving: Using Qualified Charitable Distributions (QCDs) to donate RMDs directly to a qualified charity, reducing taxable income.

Consulting with a financial advisor or tax professional is advisable to tailor strategies to individual circumstances.

Conclusion

The finalization of the IRS rules regarding inherited IRAs marks a significant shift in retirement and estate planning. Beneficiaries must be proactive in understanding and complying with these regulations to avoid penalties and optimize their financial outcomes. Staying informed and seeking professional guidance can help navigate the complexities of these new rules.