If you've invested in a traditional IRA, you probably took time to read the fine print before signing your name on the dotted line. You knew what you were getting into. However, the same may not be true for your beneficiaries following your death. If you plan to leave your IRA to someone you care about, there's a quirk you might want to be reminded of, if only to give your beneficiary (or beneficiaries) a heads-up.
We'll also offer you a gentle nudge regarding required minimum distributions (RMDs), a reminder that you might want to come up with a plan for RMDs if you haven't already done so. Let's look at RMDs first.
RMDs
As with many other types of investments, you must begin taking required minimum distributions the year you turn 73, and failure to do so can be costly. Under the SECURE 2.0 Act, if you fail to take your RMD by the IRS deadline, you must pay a 25% excise tax on money that should have been withdrawn.
The good news is that the penalty may be reduced to 10% if you correct the issue in a timely manner. In this case, "timely manner" means taking the RMD by the end of the second calendar year following the year the RMD was missed. Let's say you miss the RMD that was due to be withdrawn by Dec. 31, 2025. You have until Dec. 31, 2027, to file a Form 5329, withdraw the 2025 RMD, and pay a 10% penalty.
The issue with taking an RMD late is how easily the task can slip through the cracks. You might be on the trip of a lifetime and forget, or you (or someone you love) may be seriously ill, and you have bigger fish to fry at the moment. These tips may help ensure you don't have to deal with an RMD-related penalty:
- Aim to take it early rather than waiting until the last moment.
- Set a reminder on every calendar you use in your everyday life.
- Ask someone you trust (like a grown child) to set a reminder on their calendars so you always have a backup.
- Plan what you'll do with the money. It's less likely to be forgotten if it's earmarked for something important.
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But what if you don't need the money?
If you're in the privileged position of not needing the funds in your traditional IRA, your RMD must still be withdrawn by the due date. However, you can always accomplish something of value by using the money. Here are some examples:
- Move it into a Roth IRA (an investment that does not require you to take RMDs)
- Donate to charity
- Fund a 529 plan
- Prepay taxes with the funds
- Invest in an annuity
- Give to your family
IRA rules that will affect your beneficiaries
Before the signing of the Secure Act of 2019, beneficiaries could time IRA withdrawals to last their lifetime. Not only did it provide them with a bit of money each year, it helped them minimize their annual tax bill.
However, some accounts inherited since 2020 are now subject to the "10-year rule." The 10-year rule specifies that IRAs must be empty by the 10th year following the original account holder's death. For example, if a person dies in 2025, all funds from the inherited IRA must be withdrawn by 2035.
While the new rule is simple enough to understand on the surface, it presents a thorny question: Are the heirs subject to the 10-year rule also required to take annual RMDs?
In July 2024, the IRS cleared up the confusion. Here's how the rule breaks down:
- If you reach RMD age before you die, and
- The heir in question is not your spouse,
- They are required to withdraw the annual RMD.
Since this rule is relatively new, it would be easy for beneficiaries to overlook. However, missing an RMD could lead to a 25% penalty on the amount they were required to withdraw. The IRS rule regarding the penalty is the same for them as it is for you. They can get that penalty down to 10% if they correct the issue in a timely manner.
If you plan to leave your IRA to anyone other than your spouse, you may want to ensure they understand current RMD rules.
Despite RMD rules, a traditional IRA is a smart way to add to your portfolio and help prepare for the future.
