If you inherited a retirement account during the last several years, it’s likely you’ll have to take distributions and pay taxes on all that money within 10 years, according to new, finalized IRS rules.

Unless you’re a surviving spouse, a minor child, a disabled or chronically ill person, or a person less than 10 years younger than the retirement account owner, you’ll have to empty the account within 10 years. In some cases, annual required minimum distributions, or RMDs, must also be taken.

Before the new rule, heirs could “stretch” individual retirement account (IRA) withdrawals over their lifetime, which reduced yearly taxes. The shorter 10-year window can mean bigger tax bills in withdrawal years, particularly for high-income beneficiaries, advisers said.

“There are many things people should know if they inherit an IRA," said Mark Steber, chief tax information officer at tax preparer Jackson Hewitt. "Arguably the most important? Understand that you may owe taxes sooner or later on the money inherited and specifically, how...the rules can require the person who inherits the IRA to start receiving payments and possibly pay taxes on those monies or make other elections that can personally impact you and the taxes you owe." 

What is the 10-year rule for retirement withdrawals?

The 10-year rule stems from SECURE Act 1.0, which passed in 2019 but hadn’t been enforced because the IRS had to clear up ambiguity around whether beneficiaries had to take distributions each year or could wait and take all the money out at the 10^th year.

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In July, the IRS finally clarified the rules for inherited individual retirement accounts (IRAs) and said enforcement begins next year on accounts inherited after 2019. It said:

• If the original account owner had started taking RMDs before death, beneficiaries must continue taking annual RMDs and deplete the account by the end of year 10.
• If the original owner hadn’t taken any RMDs before death, distributions are optional for the nine years after death, but the account must be emptied by the end of the 10^th year.

One caveat: While the IRS was working on clarifying the rules between 2019 and July, the IRS waived the RMD requirements for beneficiaries. If you chose not to take a RMD while waiting for clarification, you won’t be subject to the typical 25% penalty on the amount you should have withdrawn, the IRS said. When the rules go into effect next year, the 10-year clock will still begin the year you inherited the account, which means you’ll now have fewer than 10 years to empty it.

How is an IRA taxed when inherited?

• Any amount withdrawn from an inherited, traditional IRA is taxed as ordinary income. These accounts also may be subject to annual RMDs.
• Inherited Roth IRA distributions are free of taxes and RMDs.

What will your tax bracket be in the future?

Many of former President Donald Trump’s individual tax provisions, including lower federal income tax brackets, will sunset after 2025. That means tax brackets will revert to the higher levels they were in 2017, and most people would be paying more tax on their income.

“Unless there’s a change in Congress, we’re set for higher taxes, so you need a plan based on your income,” said Joseph Patrick Roop at Belmont Capital Advisors.

If you plan to retire during the 10 years that you’re required to take RMDs and know your income will drop when you stop getting a paycheck, you may want to consider taking larger RMDs then, for example, advisers said. Or if you’re having a baby and know you’ll stop working for a time, you can plan higher withdrawals during that period, they said.

Otherwise for many, spreading withdrawals over the full 10 years can help heirs take advantage of lower tax brackets each year and avoid creeping into higher brackets, a Vanguard study showed.

“The overall difference in taxes can be meaningful while also allowing for some continued tax-deferred growth,” Vanguard said.

It also noted that those in the highest tax brackets and likely to stay there will have more limited chances to curb taxes on their inherited accounts.

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Watch your Social Security, Medicare, student loans

Americans who are receiving Social Security and Medicare or taking student loan tax deductions will need to pay extra attention, advisers said.

RMDs from inherited IRAs may boost your income enough that more of your Social Security benefit would be taxed, your Medicare premiums would rise, or you may no longer qualify to deduct the interest payments from your student loans on your taxes.

• An individual filer may have to pay income tax on half your Social Security benefit if your combined income is between $25,000 and $34,000. If your combined income is above $34,000, up to 85% of your benefits may be taxable. About 40% of people who get Social Security must pay federal income taxes on their benefits, the Social Security Administration said.
• Medicare charges a surcharge, or income related monthly adjustment amount (IRMAA), based on income.
• In 2024, Medicare Part B beneficiaries whose 2022 income exceeded $103,000 for an individual or $206,000 for a couple filing jointly pay a total premium amount ranging from $244.60 to $594 depending on income. For those with income below those thresholds, the monthly premium was $174.70. The 2025 estimates will be released later this year.
• If your modified adjusted gross income (MAGI) rises above $80,000 ($160,000 if filing a joint return), you will no longer qualify for the $2,500 in student loan interest deduction.

“It’ll take a lot of scenario planning, talking to a financial adviser, tax accountant - about how (to do) distribution to minimize the tax burden and maximize the wealth transfer,” said Joel Dickson, global head of advice methodology at Vanguard.

Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at [email protected] and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday.