‘Horribly Complex’ Inherited IRA Rule Is Confusing Taxpayers — Are You in for a Tax Surprise?

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February’s amended guidance to inherited individual retirement accounts (IRAs) by the Internal Revenue Service has holders and tax-paying beneficiaries looking for guidance on how to proceed with managing their retirement savings.

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Prior to Congress passing the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019, an IRA holder was able to name a non-spouse beneficiary to inherit an IRA, and that person could keep the IRA for their lifetime, taking out the required minimum distributions (RMDs) each year. By stretching out the required payments over years, even decades, an heir could better manage their tax-deferred IRA assets over time.

But the SECURE Act disposed of “stretch IRAs” and enforced full payouts from the inherited IRAs within 10 years of the death of the original account holder. Now, taxes will need to be paid sooner and the U.S. Treasury will get its share quicker.

Aside from creating provisions to 401(k) participation options and flexibility for employees and small businesses, the SECURE Act impacted IRA contributors significantly. According to The Wall Street Journal, in February, the IRS published proposed new rules relating to required minimum distributions for those inheriting traditional IRAs that are “horribly complex,” per Michael Jones, a certified public accountant and author from Plymouth, MN.

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Some heirs — disabled and chronically ill individuals, surviving spouses, children under “the age of majority” and beneficiaries less than 10 years younger than the deceased — are exempt from having to take full IRA payouts within 10 years, according to the accounting firm Cummings, Keegan & Co. And those inheriting Roth IRAs are not affected, because Roths don’t have RMDs and are not considered taxable income.

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But for taxpayers not exempt, the February rule tweaked the commonly held supposition pertaining to inherited traditional IRAs: That one could defer taking any payouts until the 10th year after the passing of the original IRS holder.

Now, as Forbes noted, if you have inherited a traditional IRA in 2020 or later, the Treasury Department has made it obligatory to take annual distribution payments in years 1 through 9, followed by withdrawing the balance of the IRA in year ten.

As more and more investors try to bank on tax-deferred IRA accounts rather than relying on traditional pension plans, the SECURE Act’s established regulations and the IRS’ Proposed Rule on RMDs may prompt retirees to reassess their investment plans and their choice of beneficiary.  

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Although the new IRA rule is in effect now, the matter is far from finalized. With the IRS taking taxpayer and consultant comments and holding public hearings, some tax specialists are recommending clients to wait in case the IRS makes any additional amendments to the rules.

Confused taxpayers are hoping that the IRS will clear up a lot of the misinterpretation surrounding inherited IRAs. As reported by ThinkAdvisor, leading financial advisor Ed Slott complained that the RMD rule for years 1-9 is already an established law. But with the 10-year rule in effect now, many beneficiaries are unaware that they will need to withdraw the full balance of an inherited IRA after ten years.

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Those that didn’t know the intricacies of the IRA rules are waiting to see if they will get any leeway from the IRS because, as Slott stated, industry groups “are complaining about this since some beneficiaries have already missed RMDs for 2021 they didn’t know they had to take!”

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About the Author

David Nadelle is a freelance editor and writer based in Ottawa, Canada. After working in the energy industry for 18 years, he decided to change careers in 2016 and concentrate full-time on all aspects of writing. He recently completed a technical communication diploma and holds previous university degrees in journalism, sociology and criminology. David has covered a wide variety of financial and lifestyle topics for numerous publications and has experience copywriting for the retail industry.
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