NEW INHERITED IRA RULES


The IRS announced proposed changes to the Inherited IRA Rules in February of 2022 which would require heirs to take annual withdrawals in cases where the original owner died on or after his/her required beginning date (RBD) for taking distributions. The IRS is changing its original guidance issued regarding the changes brought about by the SECURE Act where the 10-year distribution rule from an inherited Traditional IRA, Roth IRA, 401(k), 403(b) and other qualified retirement plan became law (unless otherwise noted, these retirement savings accounts will collectively be referred to as an Inherited IRA in this article). Original IRS guidance indicated disbursements within the 10-year rule were optional. This can be found within IRS Publication 590-B published in May of 2021.


The inherited IRA rules were last changed by the SECURE Act, which was passed in late 2018, with little or no time for tax planning. The SECURE Act drastically reduced the ability for most non-spousal beneficiaries to defer taxes over a long period of time which was affectionally known by tax practitioners as the “stretch IRA.” Instead, the SECURE Act mandated a full withdrawal by your beneficiaries by the end of the 10th year following the tax year of your death. No distributions were required each of the nine years as long as the account was completely liquidated by the end of the tenth year. This allowed the beneficiary a decade for tax planning by taking partial distributions only in years when the beneficiary’s income and marginal tax rates were lower, or by taking only enough to not breach the current tax bracket anytime within 9 of the 10 tax years.


Three years after we adjusted to the changes brought by the SECURE Act, the IRS introduced a new 10-year payout rule which removes the flexibility of the distributions for the nine of the ten-year periods. Non-spousal beneficiaries of an inherited IRA are now required to take at least a required minimum amount annually through the ten-year period. This severely limits the usefulness of these retirement accounts in tax and estate planning.


The most detrimental component of the new 10-year payout rule in its current form, is it may be retroactively effective to a date earlier this year. When a required minimum distribution is not made in a timely manner there is a 50% excise tax due on the amount that should have been withdrawn. Many tax practitioners along with the AICPA have urged the IRS not to implement the new 10-year payout rule, or at least waive the excise tax. When Congress proposes a law, it may or may not be passed, when the IRS proposes a rule, there is no representation to stop it from happening.


The required beginning date (RBD) marks the point when retirement savers must begin taking required minimum distributions (RMDs) from their IRA or 401(k) accounts. The SECURE Act moved this age from 701/2 to age 72 beginning in 2020. The RBD may be delayed for 401(k) participants if the retirement saver is still employed and contributing to a plan.


On August 3, 2022, the IRS posted the following charts on its website https://www.irs.gov/retirement-plans/required-minimum-distributions-for-ira-beneficiaries which show the designated beneficiary’s classifications. The distinction is hinged on the deceased owner’s RBD. As you will see calculating beneficiary RMD’s is now more convoluted than ever.


IRA owner dies on or after the Required Beginning Date

​Spouse Only Beneficiary

Non-Spouse Beneficiary

No designated beneficiary, or an estate, charity, or some trusts

Spouse may treat as his/her own,

or

Distribute over spouse’s life Table I:

Use spouse’s current age each year,

or

Distribute on owner’s age using Table 1:

Use owner’s age as of birthday in year of death.


Reduce beginning life expectancy by 1 for each subsequent year.


Can take owner’s RMD for year of death.

​Distribute using Table I

Use younger of beneficiary’s age or owner’s age at birthday in year of death.


Determine beneficiary’s age at year-end following year of owner’s death.


Use oldest age of multiple beneficiaries.


Reduce beginning life expectancy by 1 for each subsequent year.


Can take owner’s RMD for year of death.

​Table 1

Use owner’s age as of birthday in year of death.


Reduce beginning life expectancy by 1 for each subsequent year.


Can take owner’s RMD for year of death.

Table 1 is the Single Life Expectancy found in IRS Publication 590-B, Appendix B


IRA owner dies before the Required Beginning Date (RBD)

​Spouse Only Beneficiary

Non-Spouse Beneficiary

No designated beneficiary, or and estate, charity, or some trusts

Spouse may treat as his/her own,

or

Take entire balance by end of 5th year following year of death,

or

Distribute based on Table I:

Use spouse’s current age each year.


Distributions do not have to begin until owner would have turned 70 1/2.

Distribute using Table I

Use younger of beneficiary’s age or owner’s age at birthday in year of death.


Determine beneficiary’s age at year-end following year of owner’s death.


Use oldest age of multiple beneficiaries.


Reduce beginning life expectancy by 1 for each subsequent year.


Can take owner’s RMD for year of death.


Table 1

Use owner’s age as of birthday in year of death.


Reduce beginning life expectancy by 1 for each subsequent year.


Can take owner’s RMD for year of death.

Table 1 is is the Single Life Expectancy found in IRS Publication 590-B, Appendix B


You will notice the last item in the “Spouse Only” column above, states “distributions do not have to begin until the owner would have been 70 ½.” The RBD age was changed to 72 with the SECURE Act for owner-decedents who passed in 2019 or later. This is not mentioned in these new rules. Will monitor and update the above if this changes.


The Appendix B Table 1 is the Single Life Expectancy for use by beneficiaries. It starts at age 0 with a life expectancy factor of 84.6 and provides a factor for each age up to age 90 with a factor of 5.7 (held constant for age 90 and above). Let’s look at the factors for a few age groups to determine how much a beneficiary would have to withdraw each year from these new rules:

Age

30

50

60

Life Expectancy Factor

55.3

36.2

31.6

There are a few facts that need to be understood before we can begin to calculate the required minimum distribution (RMD) under the new proposed rules for each type of beneficiary. Let’s look at a Non-spouse named person (center column) as the beneficiary. The easiest way to explain this is by example. Here is the assumed fact pattern (with the action items in parentheses):

  • Deceased owner dies on July 1, 2021, and this was before his RBD (go to the second part of the table “dies before”)

  • On December 31, 2021, the IRA’s market value was $1,000,000 (decedents end of year market value)

  • Beneficiary will be 50 years old by December 31, 2022 (the year after the owner’s death)

  • Beneficiary’s Life expectancy factor is 36.2 (from Table 1 – Single Life Expectancy, Appendix B of Publication 590-B)

Now divide the market value of the inherited IRA at the previous year end by the beneficiary’s life expectancy factor. This is $1M/36.2 which yields $27,624. This is the first RMD amount the beneficiary must withdraw by December 31, 2022.


Each subsequent year, the prior year end balance of the inherited IRA is used, and a similar calculation is performed except the original life expectancy factor is reduced by 1. In year two the beneficiary’s factor would be 35.2, then 34.2 for year three, and so on for the first 9-years. In year ten the entire remaining balance needs to be withdrawn. As the divisor decreases the percentage of the required withdrawals will increase.


The beneficiary can always withdrawal more than the required minimum distribution. Be careful, if the RMD is not taken in full, the amount that should have been taken is subject to a 50% excess tax. Be sure to take it all each and every year.


Where do we go from here


Estate Planning - from the estate planning perspective, the SECURE Act constricted the stretch IRA, and now these new proposed inherited IRA rules have effectively cramped the IRA. These new rules should cause you to re-think your legacy plans. Remember retirement accounts are passed on by beneficiary designations, not by your will. You should check to see if your intended primary and secondary beneficiaries are up to date. If no beneficiary is on file, your retirement accounts most likely will end up in your probate estate and be subject to unnecessary probate costs. If you have your retirement accounts going to a trust when you die, the SECURE Act along with these new rules most likely have made your revocable trust out of date and much less tax efficient. It’s time to review your trust and possibly revoke it.


Spousal IRA - remember, by leaving your retirement accounts to your spouse, you can still stretch out the taxes due, assuming you are survived by your spouse. Consider your spouse as the primary beneficiary and then others as the secondary beneficiaries. If you plan to consume your retirement accounts while alive, these new rules won’t affect your plans.


Roth - consider contributing new monies to Roth, if eligible, and/or slowly converting your pre-tax balances to Roth. This will allow you to spread out your own tax and relieve your children or other beneficiaries from paying taxes on your balances after your death. By the time you die, your adult children may be in very high tax brackets themselves. This means the net value of your bequest could be significantly less than what you intended. Your beneficiaries will still have to draw down Roth retirement accounts over a 10-year period, although these distributions will be tax free. The bonus to you with funds in a Roth is, you are not forced to take RMD’s while you are alive. With a smart withdrawal strategy, you can manage your tax bracket by blending pre-tax and Roth withdrawals to meet your cash flow needs in retirement without paying a higher marginal tax rate. For more information of Roth accounts click Here


Alternatives to Retirement Accounts – with the new rules for inherited IRAs we need to re-think our retirement and estate plans. Consider using your retirement accounts early in retirement, even before you must take your RMD’s to meet your cash flow needs. This will preserve your other (after tax) investment accounts. Upon your death, your heirs will enjoy a stepped-up tax basis of these securities and your other appreciated assets. This means NO ONE will pay capital gains taxes on the asset appreciation that occurred on your watch.


Charitable giving - as we are re-thinking our retirement and estate plans, from the tax perspective the new rules for inherited IRAs make the residual balances of your retirement accounts an ideal source for funding gifts to charities. By designating your charities as beneficiaries from these pre-tax retirement accounts NO ONE pays the taxes on these asset transfers. The charity received the full market value upon transfer. The inherited IRA rules do not apply to charitable gifts. This same strategy can be applied to your RMD’s up to $100,000 per year with a direct transfer to a qualified charity through what is known as a QCD (Qualified Charitable Distribution). For more information on QCDs click Here


Life Insurance – as the named insured, you name your heirs as the beneficiaries. Your heirs will receive a known income tax-fee death benefit upon your death. The payout amount is still included in your gross estate for estate tax purposes, although there are some easy trust work arounds to avoid this if you believe the value of your estate will be larger than the gift and estate tax applicable exclusion amount. For more information on ILITs (Irrevocable Life Insurance Trusts) click Here


The proposed new rules from the IRS should cause a lot of taxpayers to re-think current retirement and estate plans. This doesn’t mean we should be numb to it; it just means we need to move a few things around to be as tax efficient as possible while we enjoy the fruits of our labor and fulfill our purpose.



BENEFICIARIES





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