Beneficiaries Really Just Dodged A Tax Bullet For 2022

In its proposed rules, the IRS frequently clarifies and simplifies the ambiguities and complexity introduced by new tax laws. Sometimes, despite these attempts, uncertainty persists. This was the situation with the IRS’ proposed Secure Act restrictions, which left IRA recipients, accountants, and financial advisors baffled.

Before the Secure Act’s passage in late 2019, beneficiaries of inherited retirement accounts such as IRAs, 401(k)s, 403(b)s, and 457s were obliged to take RMDs based on their life expectancies each year. A beneficiary’s RMDs would be lower if they were younger due to their longer life expectancy. The phrase “stretch IRA” was coined to describe the practice of extending an inherited IRA across several years.

This was an effective technique to delay taxes and payouts for as long as feasible, according to Eric Bronnenkant, CPA and head of tax at Robo-advisor Betterment. Notably, the existing regulations apply to individuals who inherited retirement assets before 2020.

However, the Secure Act made significant adjustments and forced non-eligible recipients to liquidate inherited retirement funds within ten years. The IRS defines these beneficiaries as anybody who is not “a surviving spouse, a handicapped individual, a chronically sick individual, a small child, or an individual less than ten years younger than the account owner.”

The IRS announced its proposed regulations on RMDs for inherited retirement accounts at the end of February 2022. The agency declared that not only must the beneficiaries dispose of the assets within ten years, but they must also provide an annual distribution depending on their life expectancy. The amount that should have been withdrawn would be subject to a burdensome excise tax of 50 percent.

Because taxpayers and their advisers did not anticipate this rule, and because the regulations have not yet been finalized, many beneficiaries are unlikely to take the required withdrawals. Steve Parrish from the Center for Retirement Income, located at the American College of Financial Services, points out. Unless these taxpayers had access to a time machine or a snitch within the Treasury, it seems unlikely they could know the unknown.

To rectify this problem, the IRS issued a notice last week. According to Adam Frank, head of wealth planning and counseling at J.P. Morgan Wealth Management, execution of the planned laws has been delayed until January 2023. People who inherited IRAs after 2019 and did not take a minimum distribution in 2021 or 2022 will not be subject to an excise tax.

What would happen if you paid an excise tax? You can seek a refund by filing an updated tax return.

Regardless of the tax reduction, inheritors should not necessarily forego payouts for the time being. For recipients in a lower tax rate, it may make sense to begin drawing payments from an inherited IRA, said Kevin J. Brady, CFP, vice president of Wealthspire Advisors. Otherwise, they may be obliged to take greater distributions later, placing them at a higher tax rate.

Remember that the final regulations for inherited retirement funds have not yet been determined. By 2023, the IRS will likely release them.

Nonetheless, if the government mandates yearly payouts in the final guidelines, as it appears likely that there are estate planning issues to consider, one is a pre-death Roth conversion, so your beneficiaries inherit a Roth IRA. The conversion of a regular IRA to a Roth IRA incurs an immediate tax liability, but withdrawals in the future are tax-free.

CFP and proprietor of Gessner Wealth Strategies Michelle J. Gessner stated This might make sense for parents in a lower tax bracket than their children. Otherwise, these assets will surely transfer to their heirs, who would then be subject to these tax laws, which effectively give around 40 percent of the money to the IRS rather than allowing it to remain in the families that control them.