If you inherited an individual retirement account, there is a key change for 2025 that — without action on your part before year-end — could trigger an IRS penalty of up to 25%.
Starting in 2025, certain non-spouse heirs, including adult children, must start taking required minimum distributions, or RMDs, while emptying their inherited IRA over 10 years, according to IRS regulations released in 2024.
The change comes as investors prepare for the “great wealth transfer,” with more than $100 trillion expected to flow to heirs through 2048, according to a December report from Cerulli Associates. Much of that wealth will eventually move from parents to adult children, and tax planning for that windfall will be important, experts say.
Some heirs should consider depleting accounts sooner than the IRS requires, depending on their tax situation, experts say.
Here are the key things to know about the 2025 change and how to avoid an IRS penalty.
Who must take RMDs for 2025
Since 2020, certain inherited accounts are subject to the “10-year rule,” which means heirs must deplete the balance by the 10th year after the original account owner’s death.
The “10-year rule” and new RMD requirement apply to most non-spouse beneficiaries, such as adult children, if the original IRA owner reached RMD age before their death.
“Most of our clients fall into that 10-year window,” and they have faced “years of ambiguity” about RMDs, said certified financial planner Kristin McKenna, president of Darrow Wealth Management in Needham, Massachusetts.
Before the IRS released guidance last year, it was unclear whether yearly RMDs were required during the 10-year drawdown. As a result, the agency waived penalties for multiple years for missed RMDs on inherited IRAs.
But starting in 2025, specific heirs must start annual RMDs or could face a 25% penalty on the amount they should have withdrawn.
It’s possible to reduce that fee to 10% by withdrawing the right RMD within two years and filing Form 5329. In some cases, the agency will waive the penalty entirely.
“A lot of clients are getting that excise tax waived” by correcting the RMD, filling out the form and providing a “reasonable explanation,” IRA expert Denise Appleby, CEO of Appleby Retirement Consulting, previously told CNBC.
Play the ‘income tax bracket game’
Even if RMDs don’t apply to your inherited IRA for 2025, most heirs still must deplete the balance within 10 years. That could require planning to avoid a giant tax hit in the final year, experts say.
For example, you can “play the income tax bracket game,” by taking withdrawals sooner during lower-earning years, said CFP Marianela Collado, CEO of Tobias Financial Advisors in Plantation, Florida. She is a member of CNBC’s Financial Advisor Council.
“There might be room to fill up the lower brackets,” when income is temporarily lower, said Collado, who is also a certified public accountant.
However, you also have to consider the tax consequences of increasing income, such as phasing out tax breaks enacted via President Donald Trump’s “big beautiful bill.”
“There are so many things to think about” when timing inherited IRA withdrawals, said McKenna, of Darrow Wealth Management. “It requires a very thoughtful analysis.”