Major IRA Rules Change in 2025: What Beneficiaries Need to Know
According to Lagradaonline, Starting in 2025, there will be significant changes to how inherited Individual Retirement Accounts (IRAs) function. For those managing an inherited IRA, understanding these changes is crucial to avoid potential fines from the Internal Revenue Service (IRS) that could impact your financial security.
Categories of Inherited IRA Beneficiaries
Inherited IRAs can be classified into two main categories: spouses and non-spouses. The rules governing these accounts differ significantly between these groups.
Rules for Non-Spouse Inherited IRAs
If the original account owner was subject to Required Minimum Distributions (RMDs) before their death, the beneficiary must continue making these yearly withdrawals starting in the year following the original owner’s death. If the original owner had not yet reached the age for RMDs, this requirement might not apply. However, it is advisable for heirs to consider taking RMDs sooner rather than later.
Joel Dickson, the global head of advice methodology at Vanguard, emphasizes the importance of multi-year tax planning to maximize the benefits of an inherited IRA. Since the SECURE Act of 2019, inherited IRAs no longer come with the tax perk allowing beneficiaries to “stretch” their withdrawals over their lifetime. If an IRA was inherited after 2020 and the beneficiary is not a spouse, minor child, disabled, chronically ill, or the recipient of certain 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.
Understanding the 10-Year Rule and Penalties
Due to previous ambiguity in the rules, many beneficiaries believed they only needed to ensure the account was empty by year 10, without needing to make RMDs. However, the IRS is reinstating penalties starting in 2025 to clarify these rules. If the original account holder had reached the age for RMDs, the heir will be required to make annual withdrawals so that the account is depleted within 10 years. Missing an RMD or failing to withdraw enough will incur a 25% penalty on the amount that should have been taken out. Fortunately, if you correct this mistake within two years, the penalty can be reduced to 10%, according to the IRS.
Strategic Withdrawals for Tax Efficiency
Beneficiaries should consider “strategic distributions” when dealing with the 10-year rule. According to Vanguard’s June research, evenly spreading withdrawals over the 10 years can help minimize tax liabilities. However, this approach is not the only strategy available.
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Judson Meinhart, a certified financial planner and director of financial planning at Modera Wealth Management, advises heirs to consider their current marginal tax rate and how it may change during the 10-year window. For instance, if you anticipate lower income years—such as during unemployment or in the early stages of retirement before Social Security benefits begin—it may be beneficial to withdraw larger amounts from the IRA during those years.
Considerations and Potential Consequences
While strategic withdrawals can optimize your tax situation, they may have unintended consequences. Increasing your income through IRA withdrawals can affect eligibility for college financial aid, alter student loan repayment terms (particularly if you’re on an income-driven plan), and raise Medicare premiums in retirement.
Conclusion
Understanding the new rules for inherited IRAs and planning accordingly can help beneficiaries navigate the complexities of managing these accounts. By staying informed and considering strategic withdrawal strategies, you can avoid penalties and enhance your financial security as you manage your inherited IRA.
