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People who inherited retirement accounts in recent years finally have guidance from the Internal Revenue Service on how to drain their accounts. A few strategies can help you avoid handing over more than necessary to the IRS.

The maddeningly confusing rules on inherited IRAs and other retirement accounts resemble a Rube Goldberg contraption. But the IRS has finally cleared up some aspects on required minimum distributions, or RMDs. Play it well and you could avoid a huge tax bill.

In guidance issued on July 18, the IRS confirmed that most nonspouse beneficiaries must make annual withdrawals from their inherited IRA or 401(k)s, provided that the original account owner had already begun taking RMDs. Think of RMDs like a faucet, says Ed Slott, an IRA expert. “Once the faucet is turned on, you can’t turn it off.”

Heirs had been in limbo since the Secure Act of 2019 eliminated the “stretch IRA” for most nonspouse beneficiaries who inherited an account on or after Jan. 1, 2020. This rule had permitted adult children and others to stretch their withdrawals over their own life expectancy, allowing for more growth in the inherited account. Lawmakers thought that was too big of a tax break and killed it to accelerate revenue from inherited accounts.

In place of the stretch, the law requires most nonspouse heirs to drain the account they inherited within 10 years after the year of the original owner’s death. But it didn’t specify the pace for pulling money out. Most tax experts initially assumed that heirs could wait until the end of the tenth year to take out all the money.

In early 2022, the IRS proposed stricter rules that would apply to those who inherited an IRA from a person who had already begun taking RMDs; in that case, they must continue to take RMDs on an annual schedule. This proposal caused so much confusion and controversy that the IRS waived the RMD requirement through this year.

The IRS’ new guidance affirmed that most nonspouse heirs have to start their RMDs in 2025, if they haven’t already. The penalty for not taking RMDs is 25% of the amount that should have been withdrawn. Here’s what you need to know.

What if I inherited an IRA before 2020?

The new rules don’t apply. You are grandfathered into the so-called stretch IRA rules that applied before the law’s passage.

What if I inherited an IRA from my spouse?

None of the changes matter to spouses, who enjoy far more flexibility when inheriting IRAs. You can roll over your spouse’s IRA into your own retirement account or keep it as an inherited account. Either way, you can stretch distributions based on your life expectancy, not over the 10 years.

Are there any other beneficiaries who can still stretch RMDs over their own lifetimes?

Yes. Surviving spouses are part of a category of special heirs called “eligible designated beneficiaries.” Also included in this group are heirs who are no more than 10 years younger than the original IRA owner, those who are chronically ill or disabled, and minor children—not grandchildren—of the original owner.

The final rule clarifies that minor children can include stepchildren and foster children. However, once the heirs reach 21, they become adults and the 10-year clock starts.

What if I inherited a traditional IRA after 2019 from someone who had begun taking RMDs?

You must begin taking RMDs in 2025 if you haven’t already. You don’t need to take retroactive RMDs for the years when the requirement was waived. However, the intervening years do count toward your calculation. To determine next year’s RMD, use IRS Table 590-B to find your life expectancy factor for the year after the account owner’s death, Slott says.

For example, say you inherited an IRA in 2020 at age 50. In 2025, you would divide the account balance at the end of this year by 31.3, your life expectancy based on being 51 in 2021, the year after you inherited the account.

The life-expectancy factor method applies in years one through nine. Then in year 10, you must withdraw the remaining balance.

How much should I really withdraw?

Be mindful of the tax consequences if you withdraw only the minimum required through year nine. That could leave you with a big balance to empty in the final year. Any amount you withdraw is counted toward your taxable income for the year. Staggering withdrawals more equally over the distribution period will make it less likely that the final distribution will trigger a big tax bill in year 10. Be mindful of your tax bracket and don’t withdraw anything that would bump you into a higher one if possible.

Another factor to consider is that the current tax rates are scheduled to expire at the end of 2025. Barring congressional action, the brackets that were lowered as part of the Tax Cuts and Jobs Act of 2017 will revert to their prior levels. Taking a higher distribution now could shave your tax bill.

One exception is if you plan to retire during the distribution period, says Evan Potash, executive wealth management advisor with TIAA in Newtown, Pa. If you know you’re going to drop down into a lower tax bracket soon, it could make sense to take only the minimum required withdrawals until you do so.

What if I inherited an IRA after 2019 from someone who hadn’t begun taking RMDs?

You don’t need to take annual RMDs, but you still have to empty the account by the end of the tenth year following the original account holder’s death. It might still make sense to withdraw some each year, to stagger your tax liability and take advantage of today’s lower rates.

What if I inherited a Roth account?

Roth accounts aren’t subject to RMD requirements but still must be drained by the end of the tenth year after the original owner’s death. Heirs don’t owe income taxes on withdrawals, so if you don’t need the money, consider leaving it alone to allow for maximum growth until year 10.

This content has been reviewed by FINRA. Prepared by Broadridge Advisor Solutions. © 2024 Broadridge Financial Services, Inc.