If you’re due to take a required minimum distribution from a qualified account, be aware of some changes to the rules. In particular, changes apply to inherited individual retirement accounts, but savers should also take note of the reduced penalties for missing an RMD.
Here’s a look at how withdrawal rules for an IRA or 401(k) may affect you in 2025.
The 10-Year Rule
If you inherit an IRA from a parent, the 10-year rule applies to you. Beginning in 2025, many IRA beneficiaries will be required to take annual withdrawals or incur a penalty. This rule generally applies to non-spousal beneficiaries if the original account owner had already reached the RMD age before death.
Previously, heirs could stretch out inherited IRA withdrawals for years as long as the account had money in it. That helped slash the heir’s yearly tax bill.
However, under the new rule, heirs who inherited an IRA after 2020 must empty the account within 10 years of the original owner’s death.
“Very simply, it adds to the tax burden of those who inherit an IRA or a qualified workplace retirement savings plan,” said Barbara O’Neill, author and certified financial planner at Annuity.org in Ocala, Florida, in an email.
It can move beneficiaries into a higher tax bracket, trigger a payment of the net investment income tax, or, for older beneficiaries, tax on Social Security and Medicare premium surcharge that applies to high earners, she added.
As a result of these tax consequences, she said, some IRA account owners may opt to name a qualified charity as the beneficiary of their IRA and gift other assets, such as appreciated securities on a stepped-up basis, to family members.
Taxpayers with significant assets in retirement accounts, such as $500,000 or more, should seek professional advice to minimize the tax burden on their heirs, O’Neill said.
In most cases, she said, long-time savers with large account balances will leave money in one or more tax-deferred retirement plans.
[READ: Retirement Accounts You Should Consider.]
Who Is Most Affected by the 10-Year Rule?
High earners who inherit an IRA will likely be the most impacted by this change.
“Oftentimes, individuals losing their parents are in their highest earning income years,” said Megan Wiley, a CFP at Badgley Phelps Wealth Managers in Seattle, in an email.
For example, a parent who dies between the ages of 80 and 90 may have children in their 50s or 60s, which are typically prime earnings years.
“The impact of this is that a majority of inherited IRA beneficiaries will now be required to withdraw assets in full from an inherited IRA during the years they will most likely fall into the highest marginal income tax bracket of their lifetimes,” Wiley said. That reduces the benefits of the inheritance to their retirements.
“The larger the IRA inherited, the greater the tax impact, given every dollar distributed from an inherited IRA is taxed at ordinary income rates,” Wiley said.
[Read: 10 Tax Breaks for People Over 50.]
Tax Strategies for 10-Year Rule
It might seem like the best way to address the tax obligation would be to spread distributions evenly over 10 years. However, in some cases, it would be advantageous to take a different tack.
“Beneficiaries should consider their own marginal tax rate each year and how life events, such as going into retirement, starting Social Security or just having a low-income year, can create opportunities for strategic withdrawals,” said Derek Munchow, founder of Augustus Wealth in Long Beach, California.
For example, he said taking larger distributions during a gap year between jobs or before reaching Medicare age might reduce the overall tax burden while avoiding costly adjustments to benefits like Medicare Part B premiums.
“On the other hand, those beneficiaries who have a higher or more steady income can benefit from evenly timed withdrawals to stay within their tax bracket,” Munchow added. “Coming to grips with these nuances is vital if you’re to maximize the inherited account’s value and minimize unforeseen penalties or tax surprises.”
Rick Miller, financial planner and investment advisor at Miller Investment Management headquartered in Manassas, Virginia, said the 10-year rule presents additional planning strategies.
“The best use of the money would be to devise a plan that has favorable consequences for your overall situation,” he said in an email.
“For example, using the inherited RMD money to fund the tax cost of converting qualified accounts and traditional IRAs into Roth IRAs would have a great deal of merit,” he said.
[See: How to Reduce Your Tax Bill by Saving for Retirement.]
Reduced Penalty for Missing an RMD
Here’s a 2025 change that account owners may appreciate: Penalties for missing an RMD have been reduced to 25% from 50%. The penalty is lowered to 10% if the mistake is corrected within two years.
“This shift reflects the IRS’s willingness to accommodate errors, especially given the complexities of RMD calculations,” said Ryan Anderson, a CFP and wealth planner at Crewe Advisors in Salt Lake City, in an email.
However, he added, the penalties remain significant. This emphasizes the need for careful tracking of distribution schedules.
For example, retirees managing multiple accounts may still face challenges coordinating withdrawals.
“While the reduced penalties provide a safety net for unintentional mistakes, they do not eliminate the need for proactive planning and regular account reviews to ensure full compliance,” Anderson said.
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What to Know About Changes to IRA Required Minimum Distributions for 2025 originally appeared on usnews.com
Update 12/12/24: This story was published at an earlier date and has been updated with new information.
