Inheriting an individual retirement account (IRA) can feel like hitting a financial jackpot for many investors. However, there’s an important change on the horizon for 2025 that could lead to unexpected penalties, according to financial experts.
Starting in 2025, if you’ve inherited an IRA, you might be required to take annual withdrawals while emptying the account within a decade—this is what’s known as the "10-year rule."
"The significant shift for 2025 is that the IRS is going to start enforcing penalties for missed required distributions," explains Judson Meinhart, a certified financial planner and director of financial planning at Modera Wealth Management in Winston-Salem, North Carolina.
Here’s what you need to understand about the updates regarding inherited IRAs.
Heirs Who Might Be Affected by Penalties
Before the Secure Act of 2019, beneficiaries were allowed to withdraw from inherited IRAs over their lifetimes, which helped manage yearly income tax impact. But since 2020, the "10-year rule" mandates that certain inherited IRAs be completely drawn down by the end of the decade following the original account holder’s passing.
For several years, the IRS didn’t impose penalties for missed required minimum distributions (RMDs) from inherited IRAs, but finalized guidance in July specified that from 2025, some heirs must take annual withdrawals during this 10-year period or they’ll risk a penalty for any missed RMDs.
This rule kicks in for beneficiaries who aren’t spouses, minor children, disabled individuals, the chronically ill, or certain trusts. Annual withdrawals will be enforced if the original account holder had reached their RMD age before passing away.
One group likely to be affected includes adult children who’ve inherited IRAs from their parents, suggests CFP Edward Jastrem, who serves as chief planning officer at Heritage Financial Services in Westwood, Massachusetts. However, he describes these regulations as a "spiderweb mess of decision-making."
Steering Clear of the ’10-Year Tax Squeeze’
Avoiding the 2025 penalty requires more than just mindful withdrawal scheduling; it’s also about dodging the "10-year tax squeeze," warns Jastrem.
In recent years, some heirs neglected to make yearly withdrawals, which could result in larger obligatory withdrawals before the 10-year period wraps up.
For instance, increasing one’s adjusted gross income can have various consequences, such as affecting Medicare Part B and Part D premiums or eligibility for premium tax credits for Marketplace health insurance, among other things.
It’s crucial to time withdrawals from inherited IRAs based on your entire tax picture, taking into account multi-year projections of your adjusted gross income, advises Meinhart.
