Three Questions to Ask When Inheriting an IRA in 2025

Since the passage of the SECURE Act in 2019, the distri­b­ution rules regarding inherited IRAs have become highly complicated—with rules that vary widely across situa­tions. How can you know which rules apply to you? And what’s the best strategy to avoid some of the adverse conse­quences of these new distri­b­ution rules?

In this article, we’ll examine three key questions to answer when inher­iting an IRA. Those answers will give you the necessary infor­mation to make the most of your inher­i­tance and avoid unnec­essary pitfalls.

1. What kind of beneficiary are you?

The SECURE Act created three different types of beneficiaries.

• Non-designated benefi­ciaries include charities, estates, and certain trusts. If it’s not a person, it’s a non-designated beneficiary.
• Eligible desig­nated benefi­ciaries include surviving spouses, disabled or chron­i­cally ill people, minor children, and people less than 10 years younger than the original owner.
• Non-eligible desig­nated benefi­ciaries are any benefi­ciaries that do not fit the criteria above. Most benefi­ciaries, except for spouses, fall into this category.

It’s critical to correctly determine which kind of benefi­ciary you are, because it will determine which distri­b­ution rules apply to you.

2. Was the original owner past their required beginning date?

In other words, was the original owner required to take an RMD for the year of death? This is important for two reasons.

First, if the original owner was required to take an RMD and passed away before taking it, the benefi­ciaries must take that RMD before the end of that year. Techni­cally, this is the final RMD required from the original owner. If there are multiple benefi­ciaries, this RMD is usually split between them, but it needn’t be. The only requirement is that the remaining RMD for the original owner be distributed before the end of the year.

Second, the owner’s required beginning date (RBD) will also determine which rules apply for the inherited IRA benefi­ciaries. Generally, if the owner is past their RBD, the benefi­ciaries must continue to take RMDs annually based on their remaining life expectancy. The first RMD from the inherited IRA would need to be taken by the end of the first year after the original owner’s death.

3. What are the rules for non-eligible designated beneficiaries?

Most of the confusion regarding inherited IRAs concerns the rules for non-eligible desig­nated benefi­ciaries. This is a very common scenario, as most children who inherit IRAs from their deceased parents find themselves in this category. There are two rules to keep in mind:

If the original owner was past their required beginning date, an RMD must be taken from the inherited IRA based on the beneficiary’s life expectancy starting the year after death. When the SECURE Act was passed in 2019, there was some confusion over this requirement, and required distri­b­u­tions were waived through 2024. However, the IRS has issued final guidance—and starting in 2025, annual RMDs will be required from beneficiaries.

The inherited IRA must be emptied entirely within 10 years. The clock starts the year after the original owner’s death. Unlike the annual RMD above, this rule applies regardless of whether the original owner was past their RBD. Here are two examples to illus­trate the point.

• Rob passes away in 2024 after his RBD and leaves his IRA to his son, Peter. Peter will need to take the RMD for the year of Rob’s death if Rob did not take it. Peter will also need to take annual RMDs based on his life expectancy starting in 2025. He must completely empty the IRA by the end of year 10 (2034).
• Margaret passes away in 2024 before her RBD and leaves her IRA to her daughter, Amy. Amy does not have to take any RMDs as her mother was not past her RBD. However, she must liquidate the account by the end of year 10 (2034).

Now that you know the rules, what are tax-efficient strategies for children who inherit their parents’ IRAs?

1. Maximize other tax-deferred accounts and use inherited IRA funds for cash flow.
   Whether an RMD is required or not, maxing out your 401(K), tradi­tional IRA, and/or health savings account may make sense. You can then compensate by taking distri­b­u­tions from the benefi­ciary IRA. This will allow you to effec­tively shift assets out of the account with the 10-year clock and into accounts that can be distributed throughout your retirement.
   
2. Shift high-growth assets from the inherited IRA into other more favorable accounts.
   If you know that the benefi­ciary IRA will need to be emptied in 10 years, it may be a good idea to holis­ti­cally rebalance your portfolio and shift your high-growth assets (like equities) into other accounts with more favorable tax treatment. This will keep your overall asset allocation the same while avoiding a large tax bill either during or after the 10-year period due to the growth of the assets in the inherited IRA.
   
3. Make qualified chari­table distri­b­u­tions.
   If you are over age 70½ (or know that you will be before the 10-year period is up), you can consider making qualified chari­table distri­b­u­tions from the inherited IRA. QCDs satisfy RMD require­ments and are not counted as taxable income on your tax return.
   
4. Take advantage of low-income years.
   If your income is variable, you should take distri­b­u­tions during low-income years when you find yourself in a lower tax bracket. Likewise, if you are planning to retire within the 10-year payout period, it may make sense for you to defer most of the distri­b­u­tions from the benefi­ciary IRA until you stop working. This will ensure that you take the funds out of the account at the lowest tax bracket possible.

Insights:

• There are three types of benefi­ciaries of inherited IRAs. Most non-spouse benefi­ciaries are considered non-eligible desig­nated beneficiaries.
• If the original owner died after their required beginning date, annual RMDs must be taken by non-eligible desig­nated beneficiaries.
• Non-eligible desig­nated benefi­ciaries must liquidate the inherited IRA account by the end of the 10-year period that starts the year after death.