Rules around inherited IRAs are set to change from 2025. As the financial landscapes evolve, staying informed about changes in regulations is crucial for effective financial planning. This change, stemming from the SECURE Act 2.0, will impact how beneficiaries manage inherited retirement accounts, with potential implications for tax revenue and estate planning strategies.
New rules for inherited IRAs
Individual Retirement Accounts (IRA) are are tax-advantaged savings accounts designed to help individuals save for retirement. The traditional IRA works according to tax-deductible contributions. The individual is only taxed once you begin withdrawing from the IRA and the tax rate is generally lower than what you would have paid if you had made already tax contributions. Other popular IRAs include Roth IRAs where your contributions are made post-tax, meaning your withdraws in retirement will not be subject to tax.
Many individuals leave their IRAs to relatives once they die. Previously, those who inherited IRAs could make them “stretch” over the retiree’s lifetimes to add to their own retirement savings. However, in 2019, the Secure Act came into affect. The Secure Act stipulates that any person who inherits an IRA from 2020 has a grace-period of 10 years to withdraw the entire account from the original owners death. This was done to accelerate tax payments owed to the government.
Confusion regarding the new rules
Since the new legislation came into affect in 2020, there has been much confusion among beneficiaries regarding how they must withdraw the money inherited through an IRA. The required yearly minimum distributions (RMDs) needed to not exceed the ten-year rule has recently been clarified by investors and the IRS alike. The RMD withdrawals will not apply to all inherited IRAs.
“You have a multi-dimensional matrix of outcomes for different inherited IRAs,” says Joel Dickson, global head of advice methodology at Vanguard, an investment advisory firm, “it’s important to understand how these rules impact your distribution strategy”. Strategic distributions will need to be made by beneficiaries to ensure that their inheritance is subject to the least amount of tax possible.
Confirmation received in July
In July of this year, the IRS confirmed that yearly RMDs will need to be taken by certain beneficiaries beginning in 2025. This comes after years of waived penalties for not making the required annual RMDs to stick to the ten-year rule. If you miss your annual RMD withdrawal, you will be subject to an additional 25% penalty on the amount you needed to withdraw. However, the IRS confirms that this can be brought down to 10% with timely correction.
Beneficiaries will need to strategically plan how and when they make their withdrawals so as not to lose out on taxes from the money, but also from tax implications from having an effective adjusted gross annual income. Strategies could involve calculating the optimal distribution amounts to minimize tax liabilities while maximizing the account’s growth potential. Understanding the implications of these new requirements can help beneficiaries make informed decisions about how to manage their inherited IRAs.
As individuals and families prepare for these changes, consulting with financial professionals will be essential to navigate the complexities of inherited IRAs effectively. By understanding these new rules, beneficiaries can better position themselves for financial success and ensure that they make the most of their inherited assets. Inheritance has changed many families lives, and it would be within their best interests to not get subject to penalties from not adhering to new regulations.
This new regulation also emphasizes the importance of proactive estate planning. Individuals with retirement accounts must consider how these changes will affect their heirs. Those creating or updating their estate plans should clearly outline their intentions for their retirement accounts and discuss these plans with their intended beneficiaries.
