One thing you can be sure of about IRAs is that the rules will continually change. Starting in 2025, non-spousal beneficiaries must take withdrawals every year as long as the original owner has reached the age where they had to take RMDs. This and a host of other rule changes are explained in a recent article from U.S. News & World Report, “What to Know About Changes to IRA Required Minimum Distributions for 2025.”
Before the rules changed, beneficiaries who inherited IRAs could stretch out their withdrawals for years if there was money in the account. This avoided major tax burdens, especially when the IRAs were large. In 2020, the new rules made it mandatory for heirs to empty the account within ten years of the original owner’s passing.
For a short while, people understood the rule to mean they could delay withdrawals until the last year. However, this has been clarified. In 2025, annual withdrawals are required, with penalties for failing to comply.
This change will most likely impact high-income earners who inherit IRAs. Timing is the issue. If a parent aged 80 or 90 has children in their 50s and 60s, the children are most likely in prime earning years.
Some are looking for alternatives because of the possibility of being shoved into a higher tax bracket, triggering a net investment income tax, or, for seniors, creating taxes on Social Security and increasing Medicare premiums. One option is to name a qualified charity as the beneficiary of the IRA and gift other assets, like appreciated securities on a stepped-up basis, to heirs.
For some taxpayers, the only tactic is to take regular distributions over ten years. Thinking more expansively, reviewing the marginal tax rate each year, and making strategic decisions from year to year might make more sense. For instance, the year one retires will be better if income drops. Another factor to consider is deciding when to take Social Security based on the size of the RMD.
Another option is to use the inherited IRA funds to pay taxes on converting qualified accounts and traditional IRAs into Roth IRAs.
One change for 2025 will benefit account owners. The penalty for missing an RMD has been cut from 50% to 25%. If the mistake is corrected within two years, the penalty drops to 10%. This is a huge change from the past and reflects the IRS’s willingness to accommodate mistakes. Figuring out how much to withdraw from an IRA has never been easy. The lowered rates soften the penalty pain.
Even with the lowered penalties, mistakes are still expensive. Consult with your estate planning attorney to optimize RMDs as part of your estate plan. You may decide to make some changes to your own retirement accounts in light of these changes. However, they should be coordinated with the rest of your estate plan.
Reference: U.S. News & World Report (Dec. 12, 2024) “What to Know About Changes to IRA Required Minimum Distributions for 2025”