For clients and professionals navigating the complexities of inherited retirement assets, understanding the updated IRS regulations is critical. The SECURE Act of 2019 and the subsequent SECURE 2.0 Act have reshaped the landscape for non-spouse beneficiaries, with significant new requirements taking effect in 2025. This summary provides a comprehensive, CPA-accurate overview of what has changed and what it means for your financial strategy.
The End of the “Stretch IRA” for Most
Prior to the SECURE Act, a non-spouse beneficiary (such as an adult child) who inherited an IRA could “stretch” the required minimum distributions (RMDs) over their own life expectancy. This allowed the account to continue growing on a tax-deferred basis for decades, providing a steady, manageable income stream while minimizing the annual tax burden.
The SECURE Act effectively eliminated this option for most non-spouse beneficiaries who inherited an IRA after December 31, 2019. The new rule, known as the 10-year rule, requires the entire balance of the inherited IRA to be distributed by December 31 of the tenth year following the original account holder’s death.
The Critical 2025 Clarification: Annual RMDs
For the past several years, there has been widespread confusion over whether annual RMDs were required within this 10-year period. Many beneficiaries and financial professionals believed that as long as the account was emptied by the end of the 10th year, distributions could be taken at any time and in any amount. The IRS has now clarified this, and the guidance taking effect in 2025 is definitive:
- If the original IRA owner died after their Required Beginning Date (RBD), meaning they were already taking RMDs, then the non-spouse beneficiary must continue to take RMDs annually in years 1 through 9. The remaining balance must then be withdrawn entirely by the end of the 10th year.
- If the original IRA owner died before their RBD, then the non-spouse beneficiary is not required to take annual RMDs. They can wait and take distributions at any time, as long as the entire account is emptied by the end of the 10th year.
This distinction is crucial and represents a major change in tax-planning strategy for thousands of beneficiaries. The IRS has waived penalties for missed RMDs for the years 2020 through 2024 to account for the confusion, but these waivers are now expired.
The High Cost of Non-Compliance
Starting in 2025, a failure to take a required annual RMD from an inherited IRA can result in a significant penalty. The penalty is a 25% excise tax on the amount that should have been withdrawn. For example, if a beneficiary’s RMD for 2025 is $10,000. Fail to take it, and the IRS can impose a $2,500 penalty, in addition to the income tax owed on the distribution when it is eventually taken.
The SECURE 2.0 Act provides a provision to reduce the penalty to 10% if the missed distribution is corrected in a timely manner, but this still represents a substantial financial hit.
Strategic Tax Planning is Now Paramount
The new rules create a more compressed tax timeline for inherited IRA beneficiaries. Unlike the “stretch” option, which allowed for decades of tax deferral, the 10-year rule can force a beneficiary into a higher tax bracket if they are not strategic with their withdrawals.
For a CPA, key planning considerations include:
- Income “Bunching”: Taking larger distributions in years of lower income can help manage the tax impact. For example, a beneficiary who plans to retire in a few years might consider taking larger withdrawals from the inherited IRA during their retirement when their income is lower.
- Coordination with Other Accounts: The tax implications of inherited IRA distributions should be considered alongside other retirement and investment accounts. For example, a client who is already taking Social Security or who has significant capital gains from other investments may want to take smaller, more consistent RMDs from the inherited IRA.
- Lump-Sum vs. Annual Distributions: While a lump-sum withdrawal can satisfy the 10-year rule, it will likely result in a massive tax bill in a single year, potentially pushing the taxpayer into the highest federal and state tax brackets. Spreading withdrawals over the full 10-year period is often the most tax-efficient strategy. For example, taking 10% each year can help a beneficiary remain in a lower tax bracket over time.
Spousal vs. Non-Spousal Beneficiaries
It is important to remember that these new rules do not apply to surviving spouses. A surviving spouse has the option to treat the inherited IRA as their own, rolling it into an existing IRA or continuing to manage it as an inherited account. This provides them with the flexibility to continue the tax-deferred growth for their lifetime.
Conclusion
The IRS’s clarification on inherited IRA RMDs for Tax Year 2025 removes the ambiguity that has existed since the SECURE Act was passed. For non-spouse beneficiaries inheriting an IRA from an individual who had already started their own RMDs, proactive tax planning is no longer optional—it is a necessity. CPA professionals should be prepared to guide clients through these new regulations to help them avoid costly penalties and minimize their tax liabilities over the 10-year distribution period. Contact TYS to get started on your overall tax planning.