If you’ve come into an individual retirement account (IRA), be aware that some major changes are on the horizon for 2025. These changes could lead to IRS penalties, so it’s wise to take action by the end of this year.
Beginning in 2025, certain heirs who are not spouses, including adult children, will need to start taking required minimum distributions (RMDs) while ensuring the inherited IRAs are drained over a decade. This follows IRS regulations expected to be revealed in 2024.
This update coincides with projections of a significant wealth transfer as over $100 trillion is anticipated to be passed down to heirs by 2048, according to a report from Cerulli Associates. Many experts suggest that as wealth moves from parents to their adult children, careful tax planning for that inheritance is going to become crucial.
Experts recommend that some heirs might want to consider withdrawing funds from their accounts sooner than the IRS requires, depending on their personal tax situations.
Here’s what’s essential to understand regarding the changes coming in 2025 and how to sidestep IRS penalties.
Who will need to take RMDs in 2025?
Since 2020, specific inherited accounts have been subject to a “10-year rule,” which mandates that heirs must deplete the account balances by the tenth year following the death of the original account owner.
This “10-year rule” and the new RMD requirements primarily affect non-spouse beneficiaries, like adult children, if the original IRA owner had reached the RMD age prior to their death.
“Most of our clients fit into that 10-year framework,” remarked Christine McKenna, a certified financial planner and president of Darrow Wealth Management in Needham, Massachusetts. “There’s been a lot of uncertainty about RMDs.”
Until last year, it was unclear whether RMDs had to be taken annually throughout the 10-year period, which led the IRS to waive penalties for missed RMDs for several years.
Starting in 2025, however, certain heirs will be required to take RMDs every year or face a potential penalty of 25% of the amount they were supposed to withdraw. They can mitigate this penalty to 10% by filing the proper Form 5329 within two years. In some circumstances, the authorities might even dismiss the penalty altogether.
Dennis Appleby, an IRA expert and CEO of Appleby Retirement Consulting, previously shared insights on this matter.
Navigating the “Income Tax Classification Game”
Even without RMDs applying to inherited IRAs, most heirs will still be required to deplete their accounts within 10 years. This will require some financial planning to avoid a hefty tax bill in the last year, experts caution.
For instance, CF Marianela Corrado, CEO of Tobias Financial Advisors in Plantation, Florida, referred to this as playing “the income tax bracket game.” She suggested that taking early withdrawals during lower-income years could be beneficial.
If there’s a temporary drop in income, Corrado noted, “there might be an opportunity to maximize the lower brackets.”
Yet, they would also need to think about the tax implications of increased earnings, especially with respects to tax breaks that saw phaseouts from President Trump’s tax reforms.
“There’s a lot to consider,” McKenna remarked regarding IRA withdrawals. “It requires thoughtful planning.”
