If you inherited an IRA in 2020 or later, you could be facing a Dec 31 deadline to start taking required minimum distributions from the account, under threat of IRS penalties.
The new rules spring from the December 2019 SECURE Act, which attacked long-beloved rules that previously allowed beneficiaries to stretch required distributions over their life expectancies, allowing them to enjoy tax-deferred growth along the way. The new rules apply to those who inherited either a traditional or Roth IRA from someone who died in 2020 or after. Those who inherited IRAs before 2020 still get to use the friendlier old rules.
The new rules apply when the deceased IRA owner was old enough to be taking RMDs of their own before they died. The new requirements do not apply to spouse beneficiaries, who will still be able to take over the inherited retirement plan assets and have them treated as if they had always been theirs. There’s also forgiving flexibility for so-called “eligible designated beneficiaries,” such as those who are disabled or chronically ill, minor children of the deceased owner, and others who are not more than 10 years younger than the deceased owner.
Between the SECURE Act’s passage and the IRS’s tardy 2024 announcement about the final rules, IRA beneficiaries were subjected to a multi-year, rolling bureaucratic fiasco, unsure what they were supposed to do. While the feds sorted things out, the IRS said it wouldn’t penalize anyone who didn’t take a required distribution in 2021, 2022, 2023 or 2024. However, those days of rare IRS leniency are over, with affected beneficiaries now required to calculate a 2025 RMD by applying a life expectancy factor to the balance of their inherited IRA as of Dec 31 of last year.
If you fail to take the RMD, the penalty is a hefty 25% of the amount you should have taken out but didn’t. That penalty is trimmed to 10% if you correct things within two years. Among other institutions, Vanguard offers an online, inherited IRA RMD calculator that anyone can use.
There’s no need to “make up” for the years when the IRS waived the penalty, and the 10-year clock is still based on the year of death. After taking RMDs driven by your life expectancy each year through Year 9, you’ll have to take out the entire remaining balance by Dec 31 of the year containing the 10th anniversary of the original IRA-owner’s death. For example, consider a situation where an IRA owner died in 2021 and left her IRA to her adult child. After taking RMD’s in 2025, 2026, 2027, 2028, 2029 and 2030, the beneficiary has to take out whatever’s left in 2031.
The RMD math drives distributions of relatively small proportions of the account before Year 10. Building on the previous example, a 58-year-old beneficiary of an inherited IRA that had a balance of $100,000 on Dec 31 2024 would have to take just $3,378 this year. All things equal, those RMD’s grow gradually larger each year. However, investment performance and withdrawals will affect the account balance used to determine subsequent RMDs.
It could be in your interest to take out more than the RMD. For example, if the account is big enough, a large, single withdrawal in Year 10 could push you into a higher tax bracket, or have a domino affect on other elements of your tax return driven by your adjusted gross income. Then there’s the question of what future tax rate you’ll be subjected to in a late-stage empire that’s $38 trillion in debt.
You may also want to factor in your future income needs. Someone who’s retiring a few years before that Year 10 lump-sum requirement may plan on taking big distributions over the last few years of the 10-year span, after his other income has dipped.
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