It used to be that Americans with tax-favored retirement
plans focused mainly on how to get money into them. Now, savers are more and
more concerned with how much must be withdrawn, and when—including at death or
after.
“Virtually all affluent families—as opposed to very wealthy
ones—now have significant assets in retirement plans, and it’s essential to
focus on them when doing estate planning,” says Natalie Choate, an attorney in
Wellesley, Mass., who specializes in retirement plans.
Total assets in traditional and Roth individual retirement
accounts, 401(k)s and similar tax-sheltered retirement vehicles grew to $22
trillion in 2020 from $3 trillion in 1995, according to the Investment Company
Institute.
These accounts have swelled from new contributions and
market growth as traditional pensions have waned, and many savers now hold a
large percentage of their assets in them. Often portions of these accounts are
left intact to heirs, who can withdraw the assets over time and benefit from
the tax deferral they provide.
Now there’s new guidance from the Internal Revenue Service
on required withdrawals for heirs of these accounts. The proposed regulations,
issued in late February, would speed up required payouts and add paperwork for
many heirs of traditional IRAs but not for heirs of Roth IRAs. They also won’t
affect most spouses who inherit retirement accounts.
The new IRS rules fill in details of the Secure Act, a law
Congress passed in 2019 that revised rules for retirement plans. One of its
changes greatly sped up required withdrawals for many retirement-plan heirs,
enraging IRA owners who had made estate plans based on prior law. The faster
money has to come out of retirement accounts, the less tax-deferred growth
there is.
Here’s what IRA owners doing estate planning need to know
about the proposed rules.
New annual withdrawals for some heirs
The Secure Act said that many heirs of traditional and Roth
IRAs (and similar accounts) whose owners died after 2019 must empty the
accounts within 10 years—not over decades as under prior law.
This rule does not apply if the heir is a spouse, someone
less than 10 years younger (often a sibling) or a disabled individual. For
minor children (but not grandchildren) who are heirs, the 10-year term doesn’t
begin until the heir turns 21. Until the term begins, the heir who is a minor
child will also have to take some annual payouts required by the law. These are
likely to be small.
Although the Secure Act’s wording was vague, prominent IRA
specialists assumed for several reasons that affected heirs could wait until
the 10th year before taking any payouts.
Instead, the new IRS guidance would require heirs subject to
the 10-year rule to take annual withdrawals from the accounts during that
period if the original owner died on or after his or her “required beginning
date” for payouts. Under current law, that’s April 1 after the year in which
the IRA owner turns 72.
For example, say that a 50-year-old inherits a traditional
IRA from her 77-year-old mother, who died early this year. According to the new
rules, this heir must take annual IRA payouts based on her life expectancy as
prescribed in IRS Pub. 590-B. Then she must withdraw the remainder when she’s
60. (She could, of course, take larger withdrawals earlier.)
While such payouts could be relatively small for a young
heir, they add paperwork, and not taking them could incur stiff penalties.
No annual withdrawals for some other heirs
Under the new rules, heirs who are subject to the 10-year
withdrawal requirement don’t have to take annual payouts during that period if
the IRA owner died before reaching his or her “required beginning date” as
described above.
For example, if a 15-year-old inherits a traditional IRA
from a grandfather who died at age 71, then this heir can wait until the end of
the 10th year to drain the account.
There’s a twist if a traditional IRA owner dies before his
or her April 1 required beginning date. Even if the original owner has already
taken a payout at age 72, the heirs subject to the 10-year rule don’t have to
take annual payouts—because the original owner never reached his or her
required beginning date.
The IRS’s focus on the required beginning date brings some
good news for people who inherited Roth IRAs after 2019. Roth IRA owners aren’t
required to take annual payouts, so the heirs don’t have to take payouts until
the end of the 10-year period.
A change to the age of majority
Under the Secure Act, minor children (not grandchildren) who
inherit a traditional or Roth IRA can delay the start of the 10-year payout
clock until they reach the “age of majority.”
This age is 18 in many but not all states. To be
consistent—and a bit generous—the IRS rules deem the age of majority to be 21.
At that point, the 10-year clock starts to run.
Relief from the 50% penalty for the owner’s last payout
Many heirs forget to take a required IRA payout the year the
account owner dies, a responsibility that falls on them rather than the
executor if the owner didn’t take one before death.
In such cases, the new rules grant a waiver of the stiff 50%
penalty if the heir takes the missing payout by the due date of their tax return,
including extensions, for the year the payout was missed.
The road ahead
The IRS is accepting comments on the proposed rules through
May 25 and will issue final guidance later. In the meantime, retirement-account
specialist Ed Slott advises holding off on missed 2021 payouts for years one
through nine until the IRS issues a clarification on retroactivity, which he
hopes will come by the end of 2022.
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