A major change looms for those inheriting individual retirement accounts (IRAs) starting in 2025. Advisors warn that failing to comply with new regulations could lead to severe penalties. Here’s what heirs must do to avoid financial setbacks.
- The New Mandate for 2025: From 2025 onwards, beneficiaries of inherited IRAs will be required to take annual withdrawals or face penalties, according to new IRS rules.
- Who Is Affected: This rule impacts most non-spousal heirs, provided the original IRA holder had already reached the required minimum distribution (RMD) age at the time of death.
- Strategic Withdrawals: Certified financial planner Edward Jastrem from Heritage Financial Services suggests that some heirs may benefit from timing their withdrawals carefully to sidestep the “10-year tax squeeze.”
Inheriting an IRA can feel like receiving a financial boon. Yet, an overlooked update to the rules in 2025 could lead to unexpected penalties, cautions financial professionals.
2025 IRA Withdrawal Rule
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Beginning in 2025, certain beneficiaries of inherited IRAs will face a new obligation: they must take annual withdrawals, fully depleting the account within 10 years. This regulation, often called the “10-year rule,” brings with it the risk of IRS penalties for non-compliance.
“The significant change is that the IRS will enforce penalties for missed required distributions,” explains Judson Meinhart, a certified financial planner and director of financial planning at Modera Wealth Management.
Heirs who neglect to take the mandated distributions from inherited IRAs could face a staggering 25% penalty. However, the IRS does allow for some relief if the error is corrected within a two-year period.
Who Is at Risk of Penalties?
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Prior to the Secure Act of 2019, beneficiaries could stretch out IRA withdrawals over their lifetime, reducing their annual taxable income. But with the introduction of the “10-year rule” in 2020, many heirs were now required to withdraw the funds within a decade of the original owner’s passing.
Previously, heirs could bypass penalties for missing required minimum distributions (RMDs), but with the IRS’s recent guidance, starting in 2025, the IRS will enforce penalties for missed distributions. The new rule applies to most non-spouse beneficiaries, excluding minors, those with disabilities, chronically ill individuals, and specific trusts. Importantly, this rule applies only if the original IRA holder had reached the RMD age before death.
One group particularly impacted by these changes are adult children inheriting IRAs from their parents. Edward Jastrem, a certified financial planner and Chief Planning Officer at Heritage Financial Services, notes that the complexity of these rules can be overwhelming. “It’s become a tangled web of decisions,” he says.
Navigating the “10-Year Tax Squeeze”
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While missing a required distribution comes with a penalty, heirs must also consider the tax implications of withdrawals. Jastrem warns about the “10-year tax squeeze,” where failing to strategically time withdrawals could result in larger required distributions toward the end of the 10-year period.
These larger withdrawals could significantly increase taxable income, which may impact other financial areas, such as Medicare premiums, eligibility for health insurance subsidies, and more. Consequently, heirs should carefully evaluate their entire tax situation before making withdrawals from inherited IRAs. This includes considering long-term projections for adjusted gross income and its potential effects.
Caution and Planning
With new rules coming into effect in 2025, it’s crucial for heirs to stay informed and plan withdrawals wisely to avoid penalties and optimize their tax situation. Consulting a professional who can navigate the evolving landscape of inherited IRAs may prove to be an invaluable step in ensuring that these funds continue to serve their intended purpose—providing financial security for the future.
FAQs
What is the new rule for inherited IRAs in 2025?
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Starting in 2025, non-spousal heirs must take annual withdrawals and deplete the IRA within 10 years or face penalties.
Who is affected by the new withdrawal rule?
Most non-spousal beneficiaries, excluding minors, disabled individuals, and certain trusts, will be impacted if the original IRA owner had reached RMD age.
What happens if I miss an RMD from an inherited IRA?
Missing an RMD can result in a 25% penalty unless the mistake is corrected within two years.
How can I avoid the “10-year tax squeeze”?
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Heirs should plan withdrawals carefully to avoid large taxable distributions in the final years of the 10-year period.
Are there exceptions to the new withdrawal rules?
Yes, exemptions apply to minor children, disabled individuals, chronically ill heirs, and certain trusts.
