IRA rules change forever in 2025 – How beneficiaries will be affected

There have been some changes to the way inherited Individual Retirement Accounts (IRAs) will work moving forward, starting in 2025. And for anyone that is in the position of having to manage one, it is important to know these changes, otherwise the Internal Revenue Service (IRS) might levy some hefty fines that could compromise your financial security.

Those who inherited IRAs can be divided into two rough categories, spouses and non-spouses.

Rules regarding inherited IRAs for non-spouses

If the original owner of the account had reached the age at which Required Minimum distributions (RMDs) are compulsory, their heir must continue making these yearly withdrawals starting one the year after their death. If the original owner had not reached the age for RMDs, this rule may not apply, but heirs should still consider taking these RMDs sooner rather than later.

Joel Dickson, global head of advice methodology at Vanguard explains that “This is about multi-year tax planning, to maximize the benefits of an inherited IRA.”
It is especially now to do this as, after the Secure Act of 2019, inheriting an IRA no longer came with a that tax perk that meant that beneficiaries could “stretch” their withdrawals over their lifetime. If an account was inherited after 2020, and you’re not a spouse, a minor child, disabled, chronically ill, or the beneficiary of certain trusts, you’re likely subject to the “10-year rule.” This rule says you have to fully empty the inherited IRA by the end of the 10th year after the original account holder’s death.

Because the rule was unclear, many thought that as long as the account was empty by year 10, RMDs were not necessary, and although the IRS has waived penalties for a few years in order to ensure that the rule is clear and that no one is getting unfairly penalized, these penalties are coming back in 2025.

According to Dickson “You have a multi-dimensional matrix of outcomes for different inherited IRAs. It’s important to understand how these rules impact your distribution strategy.”

Starting in 2025, the rule is clear. If the original account holder reached the age in which RMDs were compulsory, their heir will have to continue the yearly withdrawals in a way that the account will empty in 10 years. If you miss a required RMD or don’t withdraw enough, there will be a 25% penalty on the amount you should have taken out. Fortunately, if you correct the mistake within two years, the penalty can be reduced to 10%, according to the IRS.

Consider ‘strategic distributions’

If you’re dealing with the 10-year rule, spreading out your withdrawals evenly over the 10 years can help keep your tax bill lower, this is confirmed by Vanguard’s research from June, which points out that this strategy works well for most heirs. But this is not the only way to approach your new tax situation.

Certified financial planner Judson Meinhart, director of financial planning at Modera Wealth Management in Winston-Salem, North Carolina urges heirs to consider “strategic distributions,” as “It starts by understanding what your current marginal tax rate is and how that could change over the 10-year window”.

For example, if you expect some years with lower income, like during unemployment or the early stages of retirement before Social Security kicks in, it might make sense to take out larger withdrawals from the IRA then.

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You will have to take into account the negatives of this strategy, which is that increasing up your income this way could have some ripple effects, like affecting your eligibility for college financial aid, changing student loan repayment terms if you’re on an income-driven plan, or increasing your Medicare premiums when you’re retired.

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