If you’ve recently inherited a retirement account, you will probably need to start withdrawing funds and pay taxes on the entire balance within 10 years due to new IRS regulations.

Exceptions apply for a surviving spouse, minor children, disabled or chronically ill individuals, or someone less than 10 years younger than the account holder; these beneficiaries can stretch distributions beyond the 10-year limit. In certain cases, required minimum distributions (RMDs) may also be necessary.

Previously, beneficiaries could “stretch” withdrawals from individual retirement accounts (IRAs) across their lifetime, which helped minimize annual tax liabilities. However, the new 10-year requirement may result in larger tax payments in the years funds are withdrawn, especially for individuals with higher incomes, according to financial advisors.

“There are numerous crucial details to be aware of when inheriting an IRA,” stated Mark Steber, chief tax information officer at Jackson Hewitt. “The key takeaway? Acknowledge that you will likely incur taxes on the inherited funds either now or later, and be aware of how the rules can necessitate that beneficiaries receive funds and potentially pay taxes on those amounts or make decisions that significantly impact your personal tax situation.”

What does the 10-year rule mean for retirement withdrawals?

The 10-year rule originated from SECURE Act 1.0, enacted in 2019, which had not been enforced due to uncertainties about whether beneficiaries needed to withdraw funds annually or could wait until the end of the 10th year to extract the entire amount.

In July, the IRS clarified its stance on inherited IRAs, confirming that enforcement will commence next year for accounts inherited post-2019. The guidelines state:

• If the original account owner had begun taking RMDs before they passed away, beneficiaries need to continue those annual RMDs and deplete the account within 10 years.
• If the original owner had not taken RMDs before death, beneficiaries can choose whether to withdraw funds during the nine years following the owner’s death, but the account must be emptied by the end of the 10th year.

It’s important to note that while the IRS was working to clarify its rules from 2019 until July, the agency suspended RMD requirements for beneficiaries. Therefore, if you chose to hold off on taking an RMD during this clarification period, the usual 25% penalty for not withdrawing the required amount will not apply, as stated by the IRS. When the new rules take effect next year, your 10-year timeline will commence from the year you inherited the account, meaning you’ll have less than 10 years to withdraw everything.

How are inherited IRAs taxed?

• Withdrawals from an inherited traditional IRA are treated as regular income and will be taxed accordingly. These accounts might also be subject to annual RMDs.
• Distributions from an inherited Roth IRA are tax-free and do not require RMDs.

What might your future tax rate look like?

Many of the individual tax measures instituted during former President Donald Trump’s tenure, particularly the reduced federal income tax brackets, will expire after 2025. As a result, tax brackets will revert to levels seen in 2017, potentially leading to increased taxes for most individuals.

“If Congress doesn’t intervene, we should expect higher taxes, so it’s essential to have a strategy tailored to your income,” commented Joseph Patrick Roop from Belmont Capital Advisors.

If you anticipate retiring within the 10 years during which RMDs are required and expect a decline in income once your salary ends, financial advisors suggest considering larger withdrawals at that time. Similarly, if you’re planning to take a break from work, like after having a baby, this might also be a good time for higher withdrawals.

For many, distributing withdrawals over the entire 10 years can be beneficial, allowing heirs to leverage lower tax brackets each year and avoid shifting into higher brackets, according to a study from Vanguard.

“The overall tax implications can be significant while permitting some continued tax-deferred growth,” Vanguard stated.

It also mentioned that those in the highest tax brackets, who are likely to remain there, face limited opportunities to minimize taxes on their inherited accounts.

Keep an eye on your Social Security, Medicare, and student loans

Individuals receiving Social Security or Medicare or taking student loan interest deductions should be extra vigilant, as financial advisors recommend.

The withdrawals from inherited IRAs could elevate your income to the point where more of your Social Security benefits are taxable, your Medicare premiums may increase, or you might lose eligibility for student loan interest deductions on your tax return.

• For individual filers, if your combined income falls between $25,000 and $34,000, you may be required to pay taxes on half of your Social Security benefits. If your combined income exceeds $34,000, up to 85% of your benefits could be taxable. Approximately 40% of individuals receiving benefits are affected by this.
• The Social Security Administration confirmed that federal income taxes must be paid on Social Security benefits.

• Medicare imposes a surcharge known as the income related monthly adjustment amount (IRMAA) that is determined by an individual’s income.
• In 2024, individuals enrolled in Medicare Part B who had a 2022 income exceeding $103,000 (or $206,000 for couples filing jointly) will see their total premium range from $244.60 to $594 based on their income level. Those whose income falls below these limits will pay a monthly premium of $174.70. Details for 2025 estimates will be available later this year.
• If your modified adjusted gross income (MAGI) goes beyond $80,000 ($160,000 for joint filers), you will become ineligible for the $2,500 deduction on student loan interest.

“Planning for various scenarios will require extensive discussions with a financial advisor and tax accountant regarding how to manage distributions to reduce tax liabilities and enhance wealth transfers,” explained Joel Dickson, global head of advice methodology at Vanguard.