The Setting Every Community Up for Retirement Enhancement
(Secure) Act contained a number of changes affecting retirement accounts.
One of the most significant sets of changes are those the
act made to the inherited IRA rules for many non-spousal beneficiaries. In
particular, the rules require an inherited IRA to be emptied in 10 years.
A recent IRS publication illustrating the 10-year rule
caused confusion among advisors over whether annual distributions must be taken
over that period. An IRS spokesman told ThinkAdvisor the agency would revise
the guidance to reflect that such distributions were not, in fact, required for
beneficiaries covered by the 10-year rule.
More about that later, but first, here’s how the Secure Act
changed the rules for inherited IRAs.
Death of the Stretch IRA
For IRAs inherited prior to Jan. 1, 2020, non-spousal
beneficiaries had several options for taking distributions from the account.
One popular option was taking required minimum distributions (RMDs) from the
account based on the life expectancy of the beneficiary, especially if they
were younger than the original account owner.
Taking RMDs over their lifetime allowed the beneficiary to
stretch the tax-deferred growth of the account over their life expectancy. This
option offered some tremendous opportunities to preserve this asset and even to
pass it on to the next generation.
The Secure Act essentially eliminated the stretch IRA for
most non-spousal beneficiaries for IRAs inherited on or after January 1, 2020.
IRAs inherited prior to that date are still eligible to continue with RMDs as
before.
Spousal Beneficiaries
Spousal beneficiaries of an IRA continue to have the option
to treat the inherited IRA as their own. This allows clients to take RMDs based
on their own age in the case of a traditional IRA. They can also treat an
inherited Roth IRA as their own if they wish.
Eligible Designated Beneficiaries
The Secure Act created another class of beneficiaries known
as eligible designated beneficiaries. A spouse is included in this group, and
they can treat the IRA as an inherited IRA instead of as their own account.
Clients in this situation will need your advice to decide upon the best option
for their situation.
Other eligible designated beneficiaries include:
A beneficiary who is chronically ill or disabled
A beneficiary who is not more than 10 years younger than the
account holder
The child of the account holder who has not yet reached the
age of majority. Once they do reach the age of majority, they are no longer
considered to be an eligible designated beneficiary.
Certain trusts
These beneficiaries
may choose either the 10-year rule or take RMDs based on the single life
expectancy table.
Other Non-Spousal Beneficiaries
Non-spousal beneficiaries who do not fall into the eligible
designated beneficiary classification must withdraw the entire account balance
within 10 years of inheriting the account for IRAs inherited on or after Jan.
1, 2020.
In the case of a traditional inherited IRA, this means that
taxes will be due on the amounts withdrawn. For some clients, this could mean
that their beneficiaries will see a high percentage of the account eaten up by
taxes.
Amounts in an inherited Roth IRA are also subject to the
10-year rule, though withdrawals will be tax-free as long as the account owner
had satisfied the five-year rule prior to their death.
Confusion Over the 10-Year Rule
Recently there has been confusion over the application of
the 10-year rule — in particular, whether a beneficiary needs to take a
distribution in each of the 10 years, or whether they can withdraw the full
amount of the account over any time frame they wish within that 10-year window.
The confusion arose from a portion of IRS Publication 590-B
that discusses distributions for other designated beneficiaries that starts at
the end of page 11 and extends onto page 12. There are examples of how the RMD
is to be calculated in year one and references RMDs for subsequent years. This
flies in the face of what advisors were led to believe when the Secure Act
rules were first announced.
IRA expert Ed Slott wrote about this surprising development
April 12 in an InvestmentNews article, cautioning that the 10-year rule may not
be what he and other advisors thought.
But “the the IRS explanation isn’t very clear,” IRA analyst
Ian Berger wrote on Slott’s website two days later. “And even if it was clear,
the IRS offered the information in an informal publication that should not be
relied on.”
On April 19, Jeffrey Levine, chief planning officer of
Buckingham Wealth Partners, said in a Twitter thread that he was “100%
convinced” there had been a mistake.
Turns out he was right. MarketWatch first confirmed, late
last week, that the IRS would revise the publication.
“It’s obvious from the reading of the law that the intent of
Congress was to follow the plan of ‘distribute the entire inherited IRA within
10 years, but no other restrictions (e.g., yearly withdrawals) apply,’” says
IRA expert Jim Blankenship, a certified financial planner, enrolled agent and
the author of ”An IRA Owner’s Manual.“
“This isn’t the first time the IRS has misinterpreted
congressional intent, but usually it gets resolved pretty quickly. Just look at
the PPP loan forgiveness deductibility/non-deductibility debacle from last year
as a perfect example.”
Natalie Choate, a trusts and estates attorney in Boston with
Nutter McClennen & Fish LLP, had a simpler explanation: The IRS forgot to
update the publication for the Secure Act.
The example in question “is copied word for word from prior
editions of Publication 590-B, with just the years changed,” she said in the
May edition of Slott’s IRA Advisor newsletter.
Conclusion
The rules surrounding inherited IRAs under the Secure Act
are complex and at times confusing. Your clients need your expertise in
understanding these rules in terms of their estate planning. Clients who are the
beneficiaries of inherited IRAs need your advice to help maximize their benefit
from the inherited IRA.
In his newsletter, Slott advises beneficiaries who inherited
an IRA in 2020 to wait for more guidance from the IRS.
“Don’t rush to pay an RMD this year,” he says. “Once you’ve
taken it out, you can’t put it back in.”
Click here for the
original article.