Inherited IRAs: Important Updates for 2023

Anyone other than a spouse who inherited an IRA in 2020 or later has faced a new set of rules on when they must take distributions (and pay the IRA tax on those distributions if the money was in a traditional IRA).

The big change in 2020 requires anyone who is not a spouse and inherited an IRA starting in that year (or subsequent years) to take all the money out of the account within 10 years. Doesn’t matter if you are 21 or 71, the money needs to be drained within 10 years so the federal government can collect income tax on money from traditional IRAs. (Even inherited Roth IRAs face the same rule; though no tax will be due, the beneficiary loses the ability to keep the money growing tax-free.)

But then the IRS startled everyone a year ago when it said not only must the inherited IRA be drained in 10 years, but beneficiaries must make annual RMDs if they don’t empty the account pronto. And given the stiff penalty for not taking an annual IRA RMD—it used to be 50% and is now either 10% or 25%—folks were wondering if they faced a big bill for missed RMDs in 2021 and 2022.

To everyone’s relief, the IRS stepped in and said there would be no penalty if you didn’t take the RMD from an inherited IRA in those years.

And the IRS has now extended that to include the 2023 tax year. If you have an inherited IRA and you don’t take the RMD this tax year, there will be no penalty.

That effectively means you don’t have to take the RMD.

But that doesn’t mean you shouldn’t. You need to think through an RMD strategy over your 10 years that makes sense for you tax-wise. Sure, there’s an argument for letting the money continue to grow tax-deferred until the last year. But if it’s a large sum, having to withdraw all of it in the final year means you will likely bump yourself into a higher tax bracket that year. Remember: every penny withdrawn from a traditional IRA is treated as ordinary income for taxation.

One way to manage your tax bill is to withdraw smaller amounts each year during your 10-year window. Or over a few years. And if you find yourself in a year where your income is lower, you might want to consider withdrawing more that year, given you may be in a lower income tax bracket.