IRS issues confusing RMD guidelines for IRA recipients
David T. Mayes
You may recall that in late 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which made significant changes to the tax rules governing retirement accounts. These changes included eliminating the maximum age of eligibility to contribute to a traditional IRA. Under the old rules, traditional IRA contributions were not allowed after the age of 70 and a half. From now on, anyone with income from work can contribute whatever their age.
The law has also pushed back the age at which one must start taking distributions from a traditional IRA to 72 years from age 70 1/2. The change that had the biggest tax impact, however, was probably the elimination of the so-called “extension” of the IRA for non-spousal beneficiaries who inherit these tax-advantaged retirement accounts. Prior to the SECURE Act, these beneficiaries could take the required distributions out of their own life expectancy in most cases, from the year following the death of the original IRA owner. These legacy IRAs must now be fully distributed within ten years.
This shortened distribution period is designed to speed up when the IRS collects the tax revenue it has so graciously carried forward to help IRA owners better prepare for retirement. It will also increase the income collected by pushing many beneficiaries who inherit IRAs into higher tax brackets when they withdraw the IRA funds. The new rule applies to IRAs inherited from original or subsequent owners who die after January 1, 2020.
The IRS provides advice on the tax treatment of retirement account withdrawals in its publication 590-B, Distributions from Individual Retirement Accounts (IRA), which is updated annually. The update for use in 2020 tax preparation, however, provides confusing guidance regarding the SECURE law changes to the RMD rules. Specifically, the post includes an example of a child whose father died in 2020 naming the child as his IRA beneficiary. The child turns 53 in 2021, the first year for which the child must take a required minimum distribution of the inherited ARI (the year after the father’s death). The example then explains that the required withdrawal is calculated by taking the previous year-end IRA balance ($ 100,000) and dividing it by the child’s life expectancy factor at 53 (31 , 4) to obtain the required withdrawal amount of $ 3,185.
The post goes on to say that life expectancy charts should be ignored if the ten-year rule applies. This last point is the right approach for non-spouse IRA beneficiaries under the SECURE law. No calculation is necessary to determine the withdrawal amount required under the new rules. Any amount, including $ 0, can be withdrawn in any year before the tenth year after the death of the original IRA owner. At the end of the tenth year, the inherited IRA balance should be zero however, so it will likely be advantageous for inherited IRA owners to withdraw funds each year depending on their tax status.
Note that the 10-year rule does not apply to some IRA beneficiaries. The SECURE Act created a new category of beneficiaries which includes the surviving spouse of the owner of the IRA, a minor child of the owner of the IRA, a disabled or chronically ill beneficiary, or a person not included in the one of those categories that is no more than ten years younger than the deceased IRA owner. These beneficiaries can still use their life expectancy to calculate the required minimum annual distributions. However, in the case of a minor child who inherits from an IRA, the rule of life expectancy only lasts until the child reaches the age of majority. At this point, the ten-year rule comes into effect. Additionally, if these eligible designated beneficiaries die before fully distributing their inherited IRAs under the life expectancy rule, their beneficiaries would be subject to the ten year rule, even if that beneficiary is a spouse of the inherited owner. the IRA. Only a spouse of the original IRA owner is considered an eligible named beneficiary who can calculate the required distributions using the life expectancy approach.
Ten-year IRA recipients will need to do longer-term tax planning to develop an optimal plan for liquidating these legacy accounts. In some cases, it may make sense to take smaller withdrawals each year, or adjust the size of the withdrawals, taking larger amounts when other sources of income are lower.
David T. Mayes is a Certified Financial Planner and IRS Registered Agent at Three Bearings Fiduciary Advisors, Inc., a financial planning trust company in Hampton. He can be reached at (603) 926-1775 or [email protected]