Understanding IRA Distribution Rules for Your Beneficiaries

If you’ve invested in a traditional IRA, you likely reviewed the terms before signing. While you may understand the details, your beneficiaries might not be as prepared after your passing. If you’re considering leaving your IRA to loved ones, it’s essential to inform them about certain quirks they should know regarding distributions.

We will also remind you about required minimum distributions (RMDs), particularly if you haven’t already devised a plan for them.

Required Minimum Distributions (RMDs)

Like other investments, you must start taking required minimum distributions by the year you turn 73. Missing this deadline can incur hefty penalties. According to the SECURE 2.0 Act, if you skip your RMD by the IRS deadline, a 25% excise tax applies to the amount you should have withdrawn.

However, if you act quickly, the penalty can be reduced to 10%. To qualify, you need to take the missed RMD by the end of the second calendar year following the year it was due. For instance, if your RMD for 2025 is missed, you have until December 31, 2027, to file Form 5329, withdraw the RMD, and pay the 10% penalty.

Forgetting to take an RMD can happen easily due to life’s distractions. Perhaps you’re on a vacation or dealing with personal issues. Here are some helpful tips to avoid an RMD penalty:

• Take the RMD early rather than waiting until the deadline.
• Set reminders on all calendars you regularly use.
• Ask a trusted person, such as an adult child, to provide a backup reminder.
• Plan how you will use the RMD funds to increase the chances of remembering.

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What to Do If You Don’t Need the Money

If you’re fortunate enough not to need your traditional IRA funds, keep in mind that you still have to withdraw your RMD by the due date. Thankfully, you can use the money for beneficial purposes. Here are some ideas:

• Contribute the amount to a Roth IRA, if eligible.
• Make a charitable donation.
• Fund a 529 plan for education.
• Prepay your taxes using the funds.
• Invest in an annuity.
• Provide financial support to family members.

IRA Rules Impacting Your Beneficiaries

Prior to the Secure Act of 2019, beneficiaries could extend IRA withdrawals over their lifetimes. This approach provided them with yearly income while helping to manage tax liabilities.

However, for most accounts inherited since 2020, the “10-year rule” applies. This rule mandates that IRAs be fully withdrawn within 10 years following the original account holder’s death. For example, if someone dies in 2025, the inherited IRA must be emptied by 2035.

A critical question arose regarding whether beneficiaries are also required to take annual RMDs under this new rule. In July 2024, the IRS clarified the situation:

• If the original account holder was already subject to RMDs before their death, and
• The beneficiary is not the spouse of the deceased account holder, then
• The beneficiary must withdraw the annual RMD.

As this rule is recent, beneficiaries may overlook it. Missing an RMD could result in a 25% penalty on the required withdrawal amount. However, as with the original account holders, there’s a possibility to reduce this penalty to 10% if they rectify the missed RMD promptly.

If you plan to pass your IRA to someone other than your spouse, it’s crucial they understand the current RMD rules.

Despite the complexities of RMDs, a traditional IRA remains a valuable tool for growing your portfolio and preparing for retirement.

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