According to Lagradaonline, Significant changes are coming to the management of inherited Individual Retirement Accounts (IRAs) beginning in 2025. For individuals responsible for managing an inherited IRA, understanding these changes is crucial to avoid potential penalties from the Internal Revenue Service (IRS) that could jeopardize financial security.
Categories of Inherited IRA Beneficiaries
Inherited IRAs can be categorized into two main groups: spouses and non-spouses. The rules governing these accounts vary significantly between these categories.
Rules for Non-Spouse Inherited IRAs
If the original account owner was required to take Required Minimum Distributions (RMDs) at the time of their passing, the beneficiary must continue these yearly withdrawals starting in the year following the owner’s death. However, if the original owner had not reached the RMD age, this obligation might not apply, although it’s still wise for heirs to consider taking RMDs sooner rather than later.
Joel Dickson, global head of advice methodology at Vanguard, emphasizes the importance of multi-year tax planning to maximize the benefits of an inherited IRA. Following the Secure Act of 2019, beneficiaries of IRAs can no longer “stretch” their withdrawals over their lifetime. Instead, if the account was inherited after 2020 and the beneficiary is not a spouse, minor child, disabled, chronically ill, or a beneficiary of specific trusts, they are likely subject to the “10-year rule.” This rule mandates that the inherited IRA must be fully emptied by the end of the 10th year following the original account holder’s death.
Clarification on RMDs and Penalties
Due to confusion surrounding the previous rules, many beneficiaries believed that they only needed to withdraw funds by the end of the 10-year period, without any yearly RMDs. Although the IRS waived penalties temporarily to provide clarity, these penalties will return in 2025. According to Dickson, there exists a “multi-dimensional matrix of outcomes” for different inherited IRAs, making it essential for heirs to comprehend how these rules influence their distribution strategy.
Starting in 2025, if the original account holder had reached RMD age, beneficiaries will be required to take annual withdrawals so that the account is fully depleted within the 10-year timeframe. Missing an RMD or not withdrawing enough will incur a 25% penalty on the shortfall. Fortunately, if the mistake is rectified within two years, the penalty can be reduced to 10%, as per IRS guidelines.
Consider Strategic Withdrawals
For those navigating the 10-year rule, evenly spreading out withdrawals over the decade can help minimize tax liability. Vanguard’s research from June confirms that this strategy is generally beneficial for most heirs. However, it is not the only approach available.
Certified financial planner Judson Meinhart, director of financial planning at Modera Wealth Management in Winston-Salem, North Carolina, encourages heirs to consider “strategic distributions.” This approach involves understanding current marginal tax rates and how they might shift over the 10-year distribution period.
Timing Withdrawals for Tax Efficiency
For example, if you anticipate years of lower income—such as during unemployment or in the early stages of retirement before Social Security benefits begin—it may be advantageous to withdraw larger amounts from the IRA during those times.
However, beneficiaries must also consider potential downsides of this strategy. Increasing income through larger withdrawals could impact eligibility for college financial aid, alter student loan repayment terms if on an income-driven plan, and increase Medicare premiums during retirement.
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