New IRS regulations for inherited Individual Retirement Accounts (IRAs) are set to significantly impact beneficiaries starting in 2025. These updated rules, finalized in July 2024 after a grace period, could expose heirs to substantial penalties and higher taxes if not understood and followed.
Beneficiaries, with few exceptions, must now fully withdraw funds from an inherited IRA within 10 years of the original owner's death. This applies to both traditional and Roth IRAs. Furthermore, if the original account holder was already taking Required Minimum Distributions (RMDs), the beneficiary must continue these annual withdrawals. Failure to do so can result in a 25% penalty on the missed distribution, which may be reduced to 10% if corrected within two years.
Withdrawals from inherited traditional IRAs are taxed as ordinary income and can push beneficiaries into higher tax brackets. Inherited Roth IRAs, however, remain tax-free and RMD-free, provided the account has been open for at least five years.
Financial experts advise beneficiaries to consider spreading withdrawals evenly over the 10-year period. This strategy can help manage tax liabilities by avoiding higher tax brackets that might result from larger, lump-sum distributions taken near the end of the deadline.