Recent heirs to retirement plans got an unexpected boost when the Internal Revenue Service suggested that they could skip making required withdrawals for this year and last, a reprieve that eliminates one-time tax hits and leaves more money in a nest egg to grow.
The tax agency surprised wealth advisors late last Friday when it
"The IRS is now saying there will be no 50% penalty for not taking those RMDs, which to me appears to mean that these RMDs do not have to be taken (even though the IRS did not specifically state that in the notice)," said Ed Slott, a certified public accountant and retirement expert in Rockville Centre, New York.
The news jolted estate planners just as the annual rite of required minimum distributions, or RMDs, kicks into gear for millions of Americans amid a recent change in how retirement plans pass to heirs. Under a 2019 law, beneficiaries who aren't spouses, minor children, chronically ill, disabled or not more than 10 years younger than the plan's owner must drain inherited accounts, whether traditional or Roth, within 10 years. Before, heirs could "stretch" out withdrawals over a lifetime. The law hits beneficiaries of inherited plans whose original owner died after 2019.
Withdrawals from traditional IRAs and 401(k)s, whose contributions are made with dollars on which taxes haven't yet been paid, are taxed at ordinary rates, now a top 37%. Not making a minimum withdrawal, also known as taking a distribution, each year sparks a
Although putting money into alternative assets is already legal, some hesitate to do it because of perceived legal pitfalls.
The prior "stretch" system was a key tool for boosting wealth because it allowed assets to grow in value over a longer period of time. A separate law
That means more money can compound over a decade. But it can also create what Scott Bishop, the executive director of wealth solutions at Avidian Wealth Solutions in Houston, called a "tax time bomb," in which heirs pay one-time larger tax bills because they have to pull out larger amounts over a shorter period of time. Heirs to Roth plans, which are funded with dollars on which taxes have already been paid, don't owe any tax on withdrawals, but they still have to drain the accounts within 10 years.
The 10-year rule is a major shift for the estate planning industry. But the IRS has flip-flopped on how it will work, and even with the new reprieve, it still hasn't issued final rules. Those are still forthcoming, the agency said in its Oct. 7
"Do NOT confuse…"
What's clear for now in the IRS's reprieve is that heirs who aren't a surviving spouse, chronically ill, disabled or a child don't have to make minimum withdrawals this year and last before draining the accounts within 10 years. While spouses, sick people and children must still take required annual distributions, including for 2021 and 2022, they can do so
"With this recent IRS drop, we now know that we do not have to have taken the 2021 RMD and won't need one for 2022," Bishop said. He sent clients a note on Oct. 10 saying, "Do NOT confuse this with IRAs inherited BEFORE 2020, where RMDs ARE still required annually for beneficiaries based on their life expectancy. "
The notice makes clear that beneficiaries that are trusts, estates and charities are off the hook for withdrawals for 2021 and 2022. Timothy Steffen, the director of tax planning at Baird in Milwaukee, said that "the really big news" is that so are adults and grandchildren who are able-bodied and well.
RMD basics
The federal government wants to make sure that it gets tax revenues from retirement nest eggs and that people don't accumulate massive accounts that pass tax-free to their heirs. So it requires owners of non-inherited IRAs, 401(k)s and other defined-contribution plans whose tax bills are deferred until withdrawals are made to pull out a minimum each year once they reach age 72, whether they're retired or still working.
Taxpayers must generally take a required
Older people who are ignoring "the Great Resignation" and are still employed and contributing to an employer-sponsored retirement plan can delay a first withdrawal from that account — but not from any others — until the April 1 after they retire,
Some older Americans worry that if they return to work, they'll get less money from Social Security. In fact, the opposite is true — but advisors need to get the word out.
The minimum amount that has to be withdrawn is
Withdrawal amounts start at roughly 3.5% or so a year and increase as a taxpayer gets older,
If that IRA is invested in the S&P 500, which is down just over 24% so far this year, it's now worth only $380,000 and the withdrawal now represents 4.8% of the nest egg — close to the upper end of the 4% to 5% range that Fidelity
Flip-flops
The 2020 break on distributions was clear. But wealth advisors were left in the dark on RMDs from inherited plans for 2021. That's because the IRS has
In early 2021, the agency said that annual withdrawals would be required in years one through nine before an inherited account is emptied in year 10. Then months later it said the opposite. Last February, it shocked advisors and accountants by saying it had made a mistake and that annual distributions were, in fact, required in years one through nine.
But because that last proposal was a proposal, and not a finalized rule, advisors didn't know whether to tell clients who are heirs to make a withdrawal for 2021. The Oct. 7 notice makes clear that they don't have to for that year or for 2022. But is also left open a scenario in which heirs could be forced to make taxable "catch-up" withdrawals by year 10.
"I suppose that opens the possibility of them being delayed beyond 2023, but that doesn't seem likely," Steffen said.
For many advisors, the lingering uncertainty is throwing a wrench into estate planning techniques used for decades. The
"This RMD confusion is still an evolving process," Slott said. "The IRS issued this temporary patch, but final regulations are coming that could contain more changes."
