Inherited IRA Withdrawal Rules: What Heirs Should Know Now

Recent changes have caused a lot of confusion around inherited IRA distributions. While inheriting an IRA can be a great boost to your financial situation, it’s also something that requires careful handling.

At Advance Capital Management, we guide our clients through every step, making it easier to navigate the complex IRS rules. With that goal in mind, here’s what you need to know now about inherited IRA withdrawals.

Inherited IRA withdrawal changes

Beneficiaries of traditional IRAs have always had to pay taxes on withdrawals from inherited accounts. However, before 2020, most could spread those withdrawals over their lifetime. This strategy allowed heirs, including adult children and grandchildren, to stretch out the tax bill.

But the Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law in 2019, changed that for many.

Under the new rules, if you inherited an IRA from someone who passed away on or after January 1, 2020, you no longer have the option to extend withdrawals over your life expectancy. Instead, you’ve got two choices:

1. Take a lump sum and pay taxes on the entire amount.
2. Transfer the funds to an inherited IRA, which must be fully depleted within 10 years after the original owner's death.

For example, if you inherited an IRA in 2020, year one would be 2021, meaning the account must be completely withdrawn by December 31, 2030.

What about inherited IRA RMDs?

From the start, there was confusion surrounding these rules. Tax professionals believed that beneficiaries had the flexibility to wait until the 10th year to withdraw the full balance. This would have allowed you to choose the most tax-efficient withdrawal schedule.

But in 2022, the IRS clarified that if the original owner had already started taking required minimum distributions (RMDs), beneficiaries must also take RMDs based on their life expectancy each year from year one to year nine. (If you’re new to RMDs, learn about them here.)

However, if the original owner had not yet started RMDs, beneficiaries can wait and take distributions at any time within the 10-year period – giving them more flexibility in timing their withdrawals.

IRS penalty waivers

Due to widespread confusion, the IRS granted a reprieve. It waived penalties for anyone who failed to take RMDs from inherited IRAs in tax years 2021 through 2024. But starting in 2025, you need to comply with the RMD rules or face stiff consequences.

The penalty for missing a required distribution is 25% of the amount that should have been withdrawn. However, this can be reduced to 10% if you correct the mistake by taking the missed distribution within two years.

Inherited Roth IRAs: more flexibility

The 10-year rule also applies to inherited Roth IRAs, but there’s an important distinction: Since Roth IRAs grow tax-free, you won’t owe taxes on withdrawals – as long as the account was opened at least five years ago. Also, you may not have to take RMDs since the original owner was not required to take them.

This means you can wait up to 10 years before you withdraw it. If you don’t need the funds right away, it could be a way to maximize the tax-free growth potential of a Roth account.

Spousal inheritance: different rules apply

If you’re a spouse inheriting an IRA, the 10-year rule doesn’t apply to you. Instead, spouses can choose to roll the funds into their own IRA or create an inherited IRA.

The benefit of rolling the funds into your own IRA is that you can delay withdrawals until you reach the required age for taking RMDs, which is currently 73. This option gives you much more control over when to start taking money out and can help reduce taxes on withdrawals during your lifetime.

Bottom line

These changes primarily impact Generation X, millennials and Gen Z – the children and grandchildren who stand to inherit trillions of dollars in IRAs and other retirement assets over the next 20 years. Understanding the rules is crucial to avoiding unnecessary penalties and ensuring that you can manage the tax implications of your inheritance as effectively as possible.

To learn more, download this free Guide to Inherited Retirement Accounts.

For non-spouse heirs, it’s a big shift from the previous rules, and it requires planning. Whether you’re navigating how to handle a traditional IRA or Roth IRA inheritance, the key is to stay informed and work with a financial adviser to make smart decisions.