In 2025, there will be a significant alteration to inherited IRAs, according to an advisor. Here's how to avoid penalties.

• From 2025 onwards, heirs with inherited individual retirement accounts will be obligated to make annual required withdrawals or face penalties from the IRS.
• If the original IRA owner passed away before the age of required minimum distribution (RMD), the rule generally applies to most non-spouse beneficiaries.
• Some heirs may strategically time their withdrawals to avoid the "10-year tax squeeze," advises certified financial planner Edward Jastrem at Heritage Financial Services.

Inheriting an individual retirement account is a windfall for many investors.

Financial experts warn that a lesser-known change for 2025 could result in a costly surprise penalty.

From 2025 onwards, certain heirs with inherited IRAs will be required to make annual withdrawals and deplete their accounts over a 10-year period, according to the "10-year rule."

In 2025, the IRS will start imposing penalties for missed required distributions, as stated by Judson Meinhart, a certified financial planner and director of financial planning at Modera Wealth Management in Winston-Salem, North Carolina.

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If you fail to distribute the required minimum amount from an inherited IRA, you may face a 25% penalty. However, you can reduce the fee if you correct your RMD within two years, as per the IRS.

Here are the key things to know about the inherited IRA change.

Which heirs could face a penalty

With the passing of the Secure Act of 2019, heirs can no longer withdraw funds from inherited IRAs over their lifetime, which increases yearly income taxes.

Inherited IRAs must be depleted by the 10th year after the original account owner's death, as per the "10-year rule" that has been in effect since 2020.

The IRS has finalized guidance after years of waived penalties for missed RMDs from inherited IRAs. From 2025 onwards, certain beneficiaries will be required to take yearly withdrawals during the 10-year window or face a penalty for missed RMDs.

If the original IRA owner had not reached their RMD age before death, and the heirs were not a spouse, minor child, disabled, chronically ill, or certain trusts, then the yearly withdrawals would apply.

According to CFP Edward Jastrem, adult children who inherited IRAs from their parents could be impacted.

He stated that the rules have become a "tangled web of decision-making."

Avoid the '10-year tax squeeze'

Jastrem stated that for 2025, there will be a penalty for missed RMDs, and heirs must manage withdrawals to avoid the "10-year tax squeeze."

Some heirs have not taken annual withdrawals from inherited IRAs, which could result in larger required withdrawals before the 10-year window expires, according to him.

Adjusting gross income can affect various aspects, including Medicare Part B and Part D premiums, eligibility for the premium tax credit for Marketplace health insurance, and more.

Your tax situation, including multi-year projections of your adjusted gross income, determines the timing of inherited IRA withdrawals, according to Meinhart.