Understanding the New Landscape of Inherited IRA Distributions
The SECURE Act of 2019 fundamentally changed how inherited Individual Retirement Accounts (IRAs) must be handled, with significant implications for those who have inherited IRA assets since 2020. In 2025, these changes become even more critical, as the IRS will begin enforcing penalties for missed Required Minimum Distributions (RMDs), where applicable, after waiving the penalties from 2021-2024 due to confusion caused by the original regulations.
For individuals who have inherited an IRA in recent years, understanding these rules is important to avoid substantial tax penalties and make informed decisions about retirement account distributions. The regulations can seem complex at first, but breaking them down into their key components makes them more manageable.
The most notable change introduced by the SECURE Act relates to who can stretch distributions from an inherited IRA and for how long. Therefore, it is important to understand what beneficiary class you fall into, as there are two distinct categories, each with different distribution requirements:
Eligible Designated Beneficiaries (EDBs)
Eligible designated beneficiaries can still use the "stretch IRA" option, taking distributions over their life expectancy. This category includes:
- Surviving spouses
- Minor children of the account owner (until reaching age of majority)
- Disabled individuals (as defined by IRC Section 72(m)(7))1
- Chronically ill individuals
- Individuals not more than 10 years younger than the decedent
Non-Eligible Designated Beneficiaries (NEDBs)
Other individual beneficiaries fall into this category, and must follow the 10-year rule, requiring complete distribution of the inherited IRA by December 31st of the tenth year following the year of inheritance. For example, if the original IRA owner passed away in 2024, the inherited IRA must be fully distributed and empty by 12/31/2034.
Impact of Original Owner's RMD Status
Distribution requirements for IRAs inherited since 2020 are also affected by whether the original account owner had reached their Required Beginning Date (RBD) for RMDs:
If Original Owner Had Not Reached RBD:
- Non-eligible designated beneficiaries have no annual RMD requirements
- The entire account must still be distributed within 10 years of inheritance
- Beneficiaries can take distributions of any size during the 10-year period
- A final distribution of the remaining balance must occur by December 31st of the tenth year
If Original Owner Had Reached RBD:
- Non-eligible designated beneficiaries must take annual RMDs
- Annual RMDs are calculated based on the prior year-end inherited IRA value and beneficiary's life expectancy
- The inherited IRA must be fully distributed within 10 years
- Missing an annual RMD will trigger a 25% penalty, unless waived due to reasonable error and steps were taken to remedy the shortfall as quickly as possible, starting in 2025
Distribution Strategies Under the 10-Year Rule
Minimum Distribution Only – Taking only the required minimum distributions during the 10-year period may seem attractive, as it minimizes additional tax liability in years 1-9 and leaves more in the inherited IRA growing on a tax-deferred basis. But doing so leaves a sizable amount to distribute, and pay taxes on, in the final year.
Straight-Line Approach – For those with consistent incomes and a desire to stay on a structured pace in distributing the entire inherited IRA balance within 10 years, dividing the year-end account value each year by the number of years remaining until the account must be empty will help to avoid any outsized distribution years.
Variable Distributions – Analyze how much to distribute – while at least satisfying the minimum – each year based on other income sources and significant life events (e.g., retirement). Taking larger or smaller distributions in years when other income is lower or higher provides greater flexibility in managing your tax bracket and avoids a massive tax hit in the final year.
Numerical Examples
To compare the above strategies, consider an IRA inherited in 2024 worth $500,000. The original IRA owner was beyond their RBD, and the beneficiary is the decedent’s adult child (i.e., a non-eligible designated beneficiary). Therefore, annual distributions are required, and the account must be fully distributed by 12/31/2034.
Minimum Distribution Only:
- Years 1-9: Approximately $22,000-34,000 per year (varies based on account performance)
- Year 10: Remaining balance (potentially $400,000+ in one tax year)
Straight-Line Approach:
- Years 1-9: Approximately $50,000 - $75,000 per year (varies based on account performance)
- Year 10: Remaining balance (approximately $75,000)
Variable Distributions (e.g., inherits IRA assets at age 60 and plans to retire at age 65):
- Years 1-5: Approximately $22,000-$28,000 per year (required minimum distributions only)
- Years 6-10 (when earned income declines upon retirement): Approximately $98,000-$114,000 per year
- Year 10: Remaining balance (approximately $120,000)
Action Items for Beneficiaries
1. Determine your beneficiary status (EDB or NEDB) and applicable distribution rules
2. Calculate required minimum distributions for 2025 and beyond
3. Develop a distribution strategy that accounts for:
- Personal tax situation
- Other income sources
- Investment goals
- Estate planning objectives (including any charitable intent)
4. Work with your WFS team and tax professionals to optimize your distribution strategy
As penalty enforcement will begin in 2025, it is imperative for beneficiaries to understand their obligations and develop a plan for managing their inherited IRA assets. Whether taking minimum distributions or larger variable withdrawals, the key is to ensure compliance with the IRS while maximizing the value of retirement assets inherited through thoughtful tax and investment planning.
Read the February 2025 Financial Planning Focus:
- A 30-Year Retirement – Tips for Managing Cash Flow by Laura Nash, CFP® »
- Real Estate Planning by Matt Cohen, CFP® »
1https://www.irs.gov/pub/irs-wd/1011036.pdf
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