Don’t Get Hit With A 25% Penalty: What The New IRS Rule Means For Inherited IRAs
As the largest wealth transfer in U.S. history accelerates, millions of Americans are poised to inherit more than assets—they may also inherit unexpected tax headaches.
Beginning in 2025, the IRS will start enforcing a long-debated rule that requires certain non-spouse beneficiaries of inherited IRAs to take required minimum distributions (RMDs) each year.
While the “10-year rule”—mandating that inherited IRAs be fully depleted within 10 years—has been in effect since 2020, this marks the first time annual RMDs will be enforced. And the penalty for missing one is steep: up to 25% of the amount you should have withdrawn.
“That’s a big hit for someone who may not even realize they’ve done something wrong,” said Denise Appleby, CEO of Appleby Retirement Consulting.
What’s Changing—and Why It Matters
Under the SECURE Act, most non-spouse heirs (including adult children) must empty inherited IRAs within 10 years of the original owner’s death.
For years, it was unclear whether those heirs also had to take annual RMDs during that period. The IRS temporarily waived enforcement while clarifying the rules. Now, the agency has confirmed: If the original account owner had already reached RMD age at death, the beneficiary must take annual distributions during the 10-year window. Failure to comply could trigger severe penalties.
“The grace period is over,” said Kristin McKenna, CFP at Darrow Wealth Management. “Heirs need to start planning now—or risk losing a significant portion of their inheritance to unnecessary taxes.”
Fortunately, beneficiaries can request a penalty reduction—from 25% to 10%—if they correct the error within two years and file Form 5329 with a reasonable explanation. Still, many heirs are unaware of these nuances and could be blindsided.
Why Strategy Matters More Than Ever
Even for heirs not subject to annual RMDs, the 10-year rule poses serious tax-planning challenges. Large withdrawals made in later years could push beneficiaries into higher income brackets.
Financial advisor Marianela Collado suggests a tactical approach: “Play the income tax bracket game. Withdraw more in lower-income years to avoid a massive tax hit at the end of the 10-year window.”
For example, someone between jobs or newly retired might take larger withdrawals during those lower-income years, spreading taxes more evenly over time. However, each decision must also consider potential side effects, such as increased Medicare premiums or the loss of tax credits.
Adding to the complexity, several tax breaks from the 2017 Tax Cuts and Jobs Act are set to expire in 2026—potentially leaving heirs in a higher-tax environment if they delay withdrawals.
“There are layers upon layers to consider,” McKenna noted. “Without a coordinated plan, heirs can unintentionally create a financial mess.”
Heirs Must Act Now to Avoid Costly Mistakes
The urgency of these rule changes is amplified by the sheer scale of wealth at stake. Cerulli Associates projects that over $100 trillion will transfer from older to younger generations by 2048—much of it in retirement accounts. Yet many beneficiaries remain unaware of their tax responsibilities.
A spokesperson from Clear Start Tax warned: “People assume inherited accounts are like a windfall. But if you don’t follow the rules, that gift can quickly turn into a burden.”
Before the End of 2025, Beneficiaries Should:
- Confirm the decedent’s age at death to determine if annual RMDs apply.
- Review IRS timelines and withdrawal requirements for inherited IRAs.
- Work with a financial advisor or tax professional to design a tax-efficient withdrawal plan.
- And above all—don’t wait.
“Talk to your family, talk to your advisor, and don’t delay,” Appleby urged. “Because when it comes to the IRS, ignorance is not a defense.”
Source: MARCA
