Inheriting an IRA in 2025: New Rules and Tax Implications You Need to Know

In 2025, a significant shift is on the horizon for how millions of Americans will manage inherited IRAs, fundamentally altering the landscape of family wealth transfer. The IRS has rolled out new final regulations surrounding inherited IRAs and required minimum distributions (RMDs), building on the foundational changes introduced by the SECURE Act in 2019. As these rules come into play, understanding their implications is essential for crafting an effective inherited IRA strategy.

Key Differences Between Old and New IRA Inheritance Rules

The 10-year rule for non-spousal beneficiaries, introduced in 2020, requires most inheritors to withdraw the entire balance of an inherited IRA within 10 years. Starting in 2025, an additional change will require beneficiaries to take required minimum distributions (RMDs) each year for the remainder of the 10-year period, instead of allowing flexibility over the timing of withdrawals.

Of course, as with most updated legislation, there’s nuance to consider with an inherited IRA. The distribution requirements for beneficiaries depend on whether the original IRA owner had reached their Required Beginning Date (RBD) for RMDs:

If the original owner had begun taking RMDs:

• Beneficiaries must take annual RMDs during the 10-year period.
• The entire account balance must be distributed by the end of the 10th year.

If the original owner had not yet started RMDs:

• Beneficiaries have more flexibility in timing their withdrawals.
• They can choose to take distributions at any time within the 10-year period.
• The entire account balance must still be emptied by the end of the 10th year.

Exceptions to The New Legislation

In most circumstances, non-spouse beneficiaries, including children, relatives, or any other designated heirs, will be most impacted by this rule. However, certain “eligible designated beneficiaries” are exempt from the 10-year rule, including:

• Surviving spouses
• Minor children (until they reach the age of majority)
• Disabled individuals
• Chronically ill individuals
• Beneficiaries not more than 10 years younger than the original IRA owner

Beneficiaries who inherited IRAs before 2020 enjoy a one-generation reprieve from the SECURE Act’s new rules. These heirs can continue using the stretch IRA strategy, taking distributions over their lifetime. However, this grandfathered status expires with them. When these original beneficiaries pass away, their heirs face the new reality: the 10-year payout schedule applies, marking the end of multi-generational stretch IRAs. This transition underscores the need for flexible estate planning in light of evolving retirement laws.

Potential Penalties and Tax Implications of the New Legislation

With the new 10-year rule for inherited IRAs, missing a required distribution could lead to costly penalties. There are also some tax implications to consider when developing your own estate planning strategies. Let’s break down some key factors to know about inherited IRAs in 2025: 

25% Penalty for Missed Distributions

If you don’t withdraw the entire balance by the end of the 10-year period, the IRS applies a 25% excess accumulation penalty (also known as an excise tax) on the remaining balance that should have been distributed. This penalty, reduced from the previous 50% in 2023 by the Secure Act 2.0, is one of the strictest imposed by the IRS, underscoring just how crucial it is to adhere to these new rules.

10% Penalty Reduction

The IRS does allow some leniency if you catch and correct the oversight quickly. If you discover that a required distribution was missed and take steps to make the withdrawal within a reasonable timeframe, the penalty may be reduced to 10%. This can save a significant amount, but it requires prompt action and usually involves notifying the IRS of the correction. Consulting a tax professional immediately upon realizing the error can help you navigate the correction process efficiently.

Potential for Higher Income Taxes

Under the new rules, RMDs are taxed as ordinary income in the year they are withdrawn. This can lead to a significant increase in taxable income, potentially pushing beneficiaries into higher tax brackets. Heirs, particularly high-income earners, should be aware of how these distributions will impact their overall tax situation. An experienced tax professional can help you devise a strategy that reduces the impact on your income tax bracket to preserve more of your inheritance. 

Lost Opportunity for Tax-Efficient Growth

By forcing beneficiaries to withdraw funds sooner, the new rules limit the ability to allow the inherited IRA to grow tax-deferred over a lifetime. This shift from the previous “stretch” strategy to a condensed 10-year timeline means that beneficiaries lose the tax-efficient growth potential they once enjoyed. As a result, these accounts should be integrated into an overall financial plan sooner rather than later to maximize growth opportunities and avoid unnecessary tax losses.

Strategies for Managing an Inherited IRA

With these new rules, careful planning is essential to avoid unintended tax consequences. Some strategies to consider may include:

Strategic Distributions

Rather than withdrawing large sums at the end of the 10-year period, consider taking smaller, strategic withdrawals each year to avoid spiking your taxable income. This can help minimize the tax burden and potentially keep you in a lower tax bracket.

Roth Conversions

One potential strategy is for the original owner to convert the IRA into a traditional Roth IRA before it’s passed on to beneficiaries. Roth IRAs grow tax-free, and distributions aren’t taxed, which could be beneficial for beneficiaries expecting to be in a higher tax bracket later. However, the conversion itself is taxable, so this approach requires careful planning. Also, it’s important to note that Roth IRAs are still subject to the 10-year rule, requiring non-spousal beneficiaries to empty the account within 10 years, though without incurring income taxes on distributions.

Leveraging Low-Income Years

If you’re in a year where your income is lower than usual, such as during a career transition or early retirement, consider taking larger distributions. This allows you to maximize the benefit of a lower marginal tax rate.

Consult a Financial Advisor

Given the complexity of the new rules and the need for strategic tax planning, consulting a financial advisor is critical. An advisor can help create a personalized plan that minimizes taxes and ensures compliance with the new regulations.

Steps to Prepare for These Changes in 2025

The upcoming changes mean it’s time to review both your own estate planning and any potential inherited IRAs. Here are steps you can take to prepare for 2025:

Step 1: Schedule a Review With Your Financial Advisor

As the year draws to a close, consider scheduling a review with your financial advisor to discuss these new rules and how they will affect your estate plan. Ensure that your will, trusts, and beneficiary designations are aligned with the new regulations.

Step 2: Consider Beneficiary Designations

Ensure that your beneficiary designations are up to date. If you leave an IRA to someone other than your spouse, they will likely be subject to the 10-year rule, and you may want to consider other options, such as Roth conversions or trusts, to reduce the tax burden on your heirs.

Step 3: Consider Gifting

If you have concerns about your heirs facing large tax bills, gifting some of your assets while you’re still alive could be a tax-efficient alternative to passing down an IRA.

Step 4: Monitor Legislation Changes

Tax laws are subject to change, so stay informed about any new modifications to IRA rules. Regularly review updates to ensure your plan remains compliant and optimized for tax efficiency.

Contact Lunsford Financial Planning Today

With 2025 rapidly approaching, now is an ideal time to review your estate plan. Don’t leave important decisions for the new year — update your strategies to align with the new inherited IRA rules. The team at Lunsford Financial Planning can help. Schedule a consultation today to learn how we can help you craft a plan that addresses your unique financial situation and goals.

Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP^® in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.