Marc Ruiz: Times Columnist
The IRS recently announced some extremely important updates for beneficiaries of inherited IRAs, and parts of the update are very timely as we head into 2023.
The SECURE Act passed in 2019 and implemented in 2020 made a number of important changes to the tax laws concerning IRA accounts. One of the most significant changes involved the age when IRA owners were required to begin taking required minimum distributions (RMDs) from their accounts. Prior to the SECURE Act the age of RMD was 70 ½, now this age has been increased to 72.
The new law also changed the way that those who inherited an IRA account from a deceased IRA account owner needed to manage distributions from the inherited IRA. Prior to the SECURE ACT beneficiaries could choose between distributing the entire IRA by the end of the fifth year following the deceased owner’s year of death, or the beneficiary could choose to “stretch” their distributions according to a life expectancy calculation using IRS tables.
This stretch provision enabled the beneficiary to potentially benefit from the feature of IRA tax deferral for decades as they slowly distributed the account over time. In order to elect the stretch provision, the IRA beneficiary once again had to take a required minimum distribution from the IRA by the end of the year following the original IRA owner’s year of death. These rules provided a decently comfortable period, over a year, to get the IRA administration account complete and make distribution decisions based on the beneficiaries’ own needs and planning.
The SECURE Act eliminated both the five-year rule and the stretch provision for named, non-spouse beneficiaries and replaced these rules with a new 10-year distribution rule that required the inherited IRA be completely distributed by the end of the 10th year following the original IRA owner’s date of death. While in some ways the new 10-year rule seemed more straightforward, some questions remained about whether or not any distributions were required from the inherited IRA during the 10-year period, or did the account simply have to be distributed by the end of the 10th year? Well, recently the IRS answered this question, and did so on a bit of short notice.
First, before we go over the new rule, it's important to know that the rule applies to non-spouse, eligible beneficiaries. The rules for spousal beneficiaries enable the surviving spouse to elect to transfer the IRA into their own non-inherited IRA to be managed under regular IRA rules. There are also a couple of types of beneficiaries who are not subject to this rule, but the complications regarding these rules are beyond the scope of this column.
The new IRS rule does require RMDs to be taken from the inherited IRA during the 10-year period following the original owner’s date of death, if the original owner had reached age 72 and was subject to RMDs while they were living. In addition, the IRS is considering this further defined rule to be in effect retroactively to 2021, while also understanding beneficiaries may not have been taking distributions since that time.
To account for this retroactive rule making, the IRS is waiving the hefty 50% tax penalty for missed inherited IRA RMDs for 2021 and 2022 (2020 RMDs were waived due to COVID), but expect RMDs to begin in 2023. The RMD method to calculate distributions will however, be based on the age of the beneficiary and IRA account balance when it was inherited if the original owner passed in 2021 or 2022, not the age or account balance in 2023.
If this all seems very complicated, it certainly is. I think the key takeaway from all this rule making is for non-spouses who inherited an IRA after 2020 from an IRA owner age 72 or older when they passed, starting in 2023 it will important to make sure distributions are not being missed, and to use the right methodology in properly determine the amount of the distribution.
As mentioned, the tax penalties for missed RMDs are substantial. I suggest getting qualified tax and financial advice to help deal with this complicated new process.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com.
Securities offered through LPL Financial, member FINRA/SIPC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations
for any individual.
