Inherited IRA Rules Changed. Don’t Focus on High Taxes, Penalties

Inherited money is generally accepted, but if it’s a retirement account, beneficiaries need to be aware of the new rules that go into effect in 2025 or they could end up paying a higher penalty to the IRS.

New rules regarding inherited retirement accounts (IRAs) — traditional and Roth — were passed in 2019, but the IRS gave Americans a grace period from 2020 to 2024 as the rules were tightened. In July 2024, the agency issued final rules, which mean they can enter the previous year to access retirement accounts inherited in 2020 or later.

If Americans are not careful, they could face a 25% penalty or a tax bomb in the coming years.

“There are a lot of things people need to know when they get an IRA,” says Mark Steber, chief tax information officer at tax preparer Jackson Hewitt. Which is more important? Understand that you may owe taxes sooner or later on the money you inherit.”

What are the rules on inherited IRAs?

10-year rule: Unless you are a surviving spouse, a minor child, have a disability or long-term illness, or are 10 years younger than the retirement account owner, you must withdraw from an inherited retirement account (IRA) within 10 years, even if it is a Roth IRA.

Required minimum distributions, or RMDs: If the original owner of a traditional IRA account starts taking annual RMDs, you’ll be required to continue annual withdrawals, too. The RMD must be taken at the end of the calendar year so, the 2025 distribution should have been made in Dec. 31, 2025. If the original owner has not started taking RMDs, then the beneficiary does not have to take annuity.

Since Roth IRAs do not require RMDs, beneficiaries do not have to take them.

What if I miss the RMD deadline?

If you miss an RMD, you could face a penalty of 25% on the amount that should have been taken out, the IRS says. The penalty can be reduced to 10% “if the RMD is timely adjusted within two years,” the IRS said.

So if you forgot or didn’t know you had to take an RMD at the end of last year, you should take it right away and file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favoured Accounts with your 2025 federal tax return, the agency said.

How are inherited retirement accounts taxed?

• Any amount withdrawn, including RMDs, from an inherited IRA is taxed as ordinary income. The RMD may squeeze beneficiaries in higher tax brackets, especially if there are many years’ worth of withdrawals that need to be taken in a short period of time.
• Distributions from an inherited Roth IRA are free of taxes and RMDs as long as the account has been open for at least five years.

Can people withdraw more than the RMD amount?

Heirs can withdraw more than the required amount each year.

Vanguard encourages many beneficiaries to take equal distributions over 10 years to be eliminated in order to “utilize the lower tax brackets each year and avoid entering the higher tax brackets. The net tax difference can be meaningful while allowing for continued tax-deferred growth,” the investment management firm said in a study.

By only taking the minimum each year and then having a balloon balance at the end to meet the 10-year cap can mean that more IRA money can end up being taxed at a higher rate.

There are exceptions, Vanguard says, including:

• Taxpayers who are already in higher tax brackets may not be able to pay a lower tax rate.
• Those with variable incomes may seek larger withdrawal periods in lean financial years. “If you know you’re going to get a big bonus in 2026, maybe don’t take distributions that year,” Jonathan Fishburn, a tax and estate expert with the nonprofit wealth planning group TIAA, said in a blog post. “If you know you’re not going to get it, maybe you do.”
• Consider if income accumulation could affect eligibility for certain tax deductions or tax credits, student loans or result in higher Medicare costs from a monthly income-related adjustment amount.

Medora Lee is a money, markets and finance reporter for USA TODAY. You can find him at [email protected] and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.

This article first appeared in USA TODAY: Inherited IRA rules have changed. Don’t focus on high taxes, fines

Reported by Medora Lee, USA TODAY / USA TODAY

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