The federal government encourages retirement savings by offering a tax break for anyone who contributes to certain retirement accounts like a 401(k) or IRA. If you save money in a traditional tax-deferred retirement account, you can deduct the amount you put in on your tax return this year. That gives you more money to invest right now.
But ultimately Uncle Sam wants his tax revenue. You can't defer taxes forever because the government imposes required minimum distributions. Seniors must start withdrawing funds from tax-deferred retirement accounts starting in their 70s, and some inherited IRAs may be subject to RMDs as well. And whenever you make a withdrawal from one of those accounts, you'll have to pay the taxes you put off years ago.
The penalties for missing a required distribution can be quite steep. You could owe up to 25% of the amount you were supposed to withdraw if you don't do so in a timely manner. And you'll still have to make the withdrawal and pay the taxes on it anyway.
Recent legislation has resulted in several changes to the required minimum distribution rules, and the IRS provided finalized regulations for how it will enforce the updated legislation in July, clarifying several key points. Here are three things everyone needs to know.
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1. You must continue making RMDs for an inherited IRA
If you inherited an IRA from someone who passed away after Dec. 31, 2019, you may be subject to RMDs on that account.
The Secure Act changed the rules on inherited IRAs. Instead of being able to stretch out the withdrawals across your lifespan, you now only get 10 years on newly inherited IRAs to deplete the account. There are exceptions for spouses, minor children, beneficiaries less than 10 years younger than the IRA owner, and disabled or chronically ill beneficiaries.
It was unclear as written whether someone inheriting an IRA subject to the 10-year rule must also take RMDs in years one through nine. The IRS waived the requirements for 2021 through 2024 but said it will start enforcing RMDs for inherited IRAs starting in 2025. Anyone who inherited an IRA from an owner who was already taking RMDs will need to continue taking annual distributions.
While the RMD rule isn't retroactive, the 10-year rule still applies for anyone who inherited an IRA in 2020 or later. So, that means some beneficiaries will need to deplete the entire inherited account by 2030 after taking minimum withdrawals in 2025 through 2029.
Since beneficiaries are required to deplete the account within 10 years, it often makes sense to withdraw some amount every year to reduce the overall tax burden. Still, the IRS regulations reduce the flexibility beneficiaries may have had previously.
2. Older beneficiaries can take smaller RMDs
If you inherit an IRA from someone younger than you who already started taking RMDs, you'll have to continue taking RMDs from your newly inherited IRA. That can add an extra tax burden on your inheritance, since you likely have RMDs to take from your own accounts.
The new IRS regulations give some relief to older beneficiaries. Instead of taking RMDs based on your own life expectancy, you may be able to take RMDs based on the original owner's life expectancy. That results in a smaller distribution from the inherited account.
Additionally, since you're older than the original owner, you won't be subject to the 10-year rule noted above. As such, you can keep your withdrawals to the minimum required throughout your entire lifetime. You will, however, likely pass on the tax burden to your beneficiaries, who may be subject to higher RMDs and the 10-year rule.
3. Anyone born in 1959 should plan to start RMDs at age 73
The Secure 2.0 Act increased the RMD age from 72 to 73 starting in 2023 and then upped it again to 75 in 2033. However, this created an interesting problem for anyone born in 1959. Since they'd reach 73 in 2032, they'd have to take their first RMD by April 2033. But then, they'd be 74 in 2033, which is below the RMD age. So, do 1959 babies have to start taking RMDs at 73 or 75?
The IRS proposed a rule to clarify the lapse in the Secure 2.0 Act, which would make their required minimum distribution age 73. The following table indicates your RMD age based on the year you were born if the proposed rule goes into effect.
| Birth Year | RMD Age |
|---|---|
| Pre-1949 | 70 1/2 |
| 1949-1950 | 72 |
| 1951-1959 | 73 |
| 1960 or later | 75 |
Data source: IRS.
Keep in mind you can delay your first required minimum distribution until April 1 of the following year. That said, your next distribution must come out by Dec. 31 of that year, meaning delaying your first RMD will result in two distributions in a single year. It often makes sense to take your first distribution in the year you reach your RMD age to reduce your overall tax liability.
