New IRS Guidance on Inherited IRAs
The IRS issued recent guidance that proposes some new interpretations to the SECURE Act of 2019. Recall that one of the most despised changes made by the SECURE Act was the elimination of the “stretch IRA” for non-spouse beneficiaries.
Prior to 2019, non-spouse beneficiaries were allowed to take required distributions based on their own age, which helped to extend the life of the IRA. The SECURE Act eliminated this treatment and instituted a mandatory 10-year IRA distribution requirement. Since IRA distributions are taxed as ordinary income, the non-spousal heir’s tax bills could climb considerably with the 10- year distribution requirement.
Although the wording in the SECURE Act was a bit vague, most people in the industry interpreted the new rule as giving the heir flexibility in scheduling the withdrawals over the 10-year period. One may choose to take it all out in year 1 or wait and take everything in year 10.
Better yet, you could try to minimize your overall tax bill by adjusting the amount of the IRA distribution each year based on your overall taxable income. As long as the entire inherited IRA account is depleted by the end of year 10, the pathway to get there is flexible.
Well, apparently the IRS does not agree with the common industry interpretation of the 10-year payout requirement. Guidance issued by the IRS in late February calls for a minimum annual distribution from inherited IRAs account owned by non-spouse beneficiaries if (big if) the original IRA owner died on or after his or her required beginning date.
The SECURE Act changed the age of traditional IRA required withdrawals to age 72. If the owner dies after age 72, the heir will face required annual distributions as well as having to have the entire account depleted by the 10-year mark. Fortunately, the required annual withdrawal for the inherited IRA is based on the heir’s age (not the original IRA owner).
The new IRS guidance is now open to public comments and a hearing is scheduled for June 15th, 2022. Final regulation should come at some point afterwards.
If this proposal is adopted, it has the potential to make Roth conversions more attractive, it will make charitable distributions from IRAs more attractive, and it will make IRA planning a much more important part of most everyone’s estate planning. It has been reported that there is now over $22 trillion in tax deferred accounts.
The benefit of tax deferred income is only one-side of the equation. Everyone should be attuned to the potential future tax challenges from overly funding tax deferred accounts.