Updated Guidance and Potential Changes from the IRS on the SECURE Act: The Inherited IRA Distribution Rule and the Five-Year Payout Rule
As you may recall, the SECURE Act was passed in late 2019 to apply in the years 2020 onward. Although complex, many of the rules around inherited IRAs were relatively straightforward up until very recently, that is. The IRS provided guidance on these SECURE Act provisions this year, surprising many, specifically around distributions and payouts on inherited accounts. The IRS has been considering comments and likely will share more information by year-end to determine the official rules to be followed. Still, knowing what may be coming ahead is essential so that you can plan accordingly.
Update as of 10/24/2022 –
The IRS recently shared more direct guidance in regards to required distributions on retirement accounts inherited after 2020. The IRS clarified that they would NOT be requiring distributions on these inherited accounts for year 2021 or 2022 for the specified beneficiaries. So, if you were concerned about missing RMDs on these accounts, you may not need to take them this year. That said, the IRS is still not clear as to whether or not they will be requiring annual distributions from years 2023 and onward. Stay tuned for more information as we receive it.
The Inherited IRA Distribution Rule
One of the main topics for interpretation is how a retirement account beneficiary must take distributions. A retirement account inherited by anyone who is a "non-eligible designated beneficiary" is generally required to entirely distribute that account within ten years. Everyone was under the impression that the new 10-year RMD (required minimum distribution) rule meant that a beneficiary must deplete the account entirely within the ten-year period but that it didn't matter whether that was taken out all in year one, spread out over the ten years, or delayed until the very last moment. The beneficiary was believed to have flexibility regarding when and how much they took for distributions as long as it was depleted by the end of the ten years. The new guidance from the IRS states otherwise. In a huge surprise to everyone, the IRS states that the account must still be depleted within the ten-year period but that beneficiaries (outside of eligible designated beneficiaries) may also be forced to take annual RMDs based on life expectancy.
The IRA Five-Year Payout Rule
Secondly, non-designated beneficiaries such as estates, certain trusts, etc., will be subject to a five-year payout rule if distributions had not begun before the original owner’s death. Many savers may have a primary beneficiary as their spouse or a loved one. Often the contingent beneficiary is overlooked or set to be paid to some specific types of trusts. Based on this ruling, it is even more critical now to have thoughtful estate planning in place. At the very least, ensuring you have named beneficiaries on your retirement accounts, including contingents in case your primary beneficiary were to pre-decease you, is vital.
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We will know more by the end of the year. In the meantime, there are important planning considerations to prepare for if this guidance becomes the rule. Although the IRS has not commented directly on how they will handle missed RMDs, if this new guidance is carried through, many will likely have missed 2021 RMDs for accounts inherited after the passing of the SECURE Act (after 12/31/2019). Presumably, many may not have taken distributions, so they may be required to take one for 2022. Additionally, they may be required to true up any distribution amounts that should have been paid out for the tax year 2021 to make up for any discrepancy. In this scenario, the hopes are that the IRS will accept a letter of apology (Form 5329) to forgive the significant 50% penalties typically incurred from the missed 2021 distribution (Form 5329). Still, it will be critical to closely watch for further guidance from the IRS. No action is required right now, but it is essential to keep an eye on this and consider any liquidation strategies ahead of time, if needed, to prepare for possible required distributions over the past two years.
Do you have questions about what you have read? We're here to help! Get connected to a member of the Mainsail team below who will be able to walk you through these changes and help you prepare should this impact your particular financial situation.