There are two kinds of headlines in financial planning: stock pricing and rule changes. If you follow the news, you might think stock prices are the bigger deal. In my opinion, it’s the rule changes that deserve far more attention. We know stocks will change, but when rules change, our planning has too as well.
While the SECURE Act 2.0 has been out for a little over 3 years, January 2025 was the starting line for new rules surrounding inherited IRAs, RMDs, and penalties for missing them. If you or anyone you know received an inherited IRA in the last few years, here’s a primer on what has changed and what you need to know.
Elimination of the "Stretch" IRA
Previously, non-spouse beneficiaries could "stretch" required minimum distributions (RMDs) from an inherited IRA over their lifetime, allowing for extended tax-deferred growth.
The SECURE Act of 2019 replaced this with a 10-year rule, mandating that most non-spouse beneficiaries deplete the inherited account within ten years of the original owner's death. SECURE Act 2.0 upholds this rule and provides further clarification.
Clarification on Required Minimum Distributions
A key point of confusion has been whether beneficiaries must take annual RMDs during the 10-year period.
The IRS has clarified that if the original account owner had already begun taking RMDs before their death, the beneficiary is required to continue taking annual distributions based on their life expectancy during the 10-year period.
Conversely, if the original owner had not started RMDs, the beneficiary could choose to withdraw any amount at any time as long as the entire account balance is distributed by the end of the tenth year following the owner's death.
Penalty for Missed Distributions
Starting January 1, 2025, failing to take a required distribution from an inherited IRA will result in a penalty of 25% of the RMD amount. However, if the error is corrected promptly, the penalty may be reduced to 10%.
Planning Considerations
As you might have noted from the paragraph above, 2025 is a significant date for this rule change. That’s why it’s important that if you inherited an IRA in the last few years, we need to take a look at the financial planning needed on your end to maximize its value and avoid losses to excess tax and penalties.
If you have questions about this, please feel free to give us a call. If someone you know may be in this situation, I invite you to pass this along to them.