As the year-end approaches, financial planners are chasing down the last of their clients who have still not made their required minimum distributions (RMDs) from their retirement accounts. The penalties can be 10%-25% of the missed distribution, depending on how quickly the error is corrected. For instance, if you have a mandatory withdrawal of $20,000 from an IRA, then if you miss the deadline at the end of the year you could owe a penalty of up to $5,000. You can see why your adviser may be trying to get in touch with you!

In short, distributions are mandatory for two broad categories of retirement accounts. The first concerns people in their 70s or older who have passed their required beginning date, which varies given their birth year. For simplicity, let’s call this group retirement account owners. The second category applies to people of most ages for inherited IRAs, inherited Roth IRAs and other inherited retirement accounts. For this group let’s label them retirement account inheritors.

Retirement account owners

If you turn age 73 or older this year and have an IRA or other pre-tax retirement account, then you must take money out of that account each year with limited exceptions. For that first distribution, the IRS gives you a grace period until April 1 after the year you turn 73. While there are IRS tables to compute the RMD, it’s about 4% of the value of the account to start. As you get older, the annual withdrawals increase as a percentage of your account. Another note is that those who were born in 1960 or later will get to start their RMDs when they turn 75.

Retirement account inheritors

The rules for inheritors are more complex and generally require larger withdrawals than the first category. Although the relevant laws were passed in 2019 and 2022, there were so many complexities and considerable room for interpretation that final rules just came out this year.

Annual distributions usually required

With the latest revisions, most non-spouses (often adult children) who inherit a retirement account from a person taking required distributions must withdraw from their inherited account each year. If you inherited an IRA from your 74-year-old father taking RMDs, you’ll likely need to take money out of the account every year per the IRS tables. Recent inheritors have had a free pass for mandatory withdrawals over the last few years as the rules were being finalized. Now with the final rules issued, inheritors should plan now for mandatory distributions next year.

10-year rule

Another recent change is that most non-spouses who inherit a retirement account are only given 10 years to withdraw all funds in the account. This change affects those who inherited accounts in 2020 or later. One wrinkle in these rules is that even if you skipped distributions in previous years doesn’t mean you can delay the deadline when the inherited retirement account must be depleted. If you inherited an IRA in 2021 as a non-spouse, most likely you will need to draw down the account by the end of 2031.

The takeaway here is that even though you may be eligible to skip your inherited account RMD this year, you may still want to take a distribution now. Most inherited retirement accounts, like IRAs, are pre-tax. Withdrawals are taxed as ordinary income, which can affect your tax situation. It can make sense to spread out your withdrawals over as many years as possible to avoid going into a higher tax bracket.

As you can see, the inherited retirement distribution rules are unfortunately extremely intricate. Spouses, minors, the chronically ill and disabled, trusts and inheritors who are less than 10 years younger than the deceased person all fall into special categories with different rules. It also matters whether the person who died had reached their mandatory distribution age or not.

Managing required withdrawals, especially for inherited accounts, is tricky but essential. Plan early to avoid penalties and reduce your tax burden. When in doubt, consult a financial or tax professional to get you going on the right path.

David Gardner is a certified financial planner and is admitted to practice before the IRS. He recently retired from an independent investment advisory firm and continues to write about financial topics. As financial planning is only possible after knowing the client, the column is not intended to be personal financial or tax advice. Data presented is believed to be accurate at the time of writing.