Should IRA Heirs Consider Taking Higher Distributions Now?
The IRS recently finalized rules on what are known as required minimum distributions (or RMDs) as well as mandatory withdrawals for certain individual retirement accounts (IRAs) and other plans that have been inherited.
In final regulations issued July 18, the IRS made it clear that most non-spouse IRA beneficiaries have only ten years after the original IRA owner's death to completely withdraw IRAs that have been inherited.
Additionally, these heirs also may be required to take yearly RMDs. Whether such RMD is required has been a source of disagreement among tax pros for some time now. Because of the ten-year depletion rule, some advisors didn't think yearly RMDs would apply, while others didn't see any authority for NOT takings the RMDs. It took almost five years for the IRS to settle the matter.
For heirs finding themselves in this situation, conventional tax planning wisdom would say to only take the bare minimum required each year and then deplete the account in year 10, thus deferring the tax liability as long as possible and keeping the money working for you on a tax-deferred basis as long as possible.
Here's the thing though. Conventional wisdom isn't always appropriate. In some situations, heirs could end up paying more tax overall if they only take the minimum amounts required in years 1 through 9.
For some background that may help this make more sense, prior to 2019, heirs could take advantage of what became to be know as "stretch" retirement account withdrawals, so termed because typically the heirs could parse out their RMDs over their own lifetimes. This typically resulted in smaller tax bills and greater growth in the account since more money continued to be invested in the account.
The Secure Act of 2019 changed all that. Now, beneficiaries who are not the spouse of the account owner, a minor, disabled, chronically ill or certain trusts, can no longer take advantage of the lifetime stretch. Instead, they have only 10 years to entirely withdraw the funds.
Further, if the original account owner had reached the age that required them to begin taking RMDs, the IRS confirms now the beneficiaries must continue annual RMDs as well, something many have not been doing since passage of the Act. Failure to take the mandated RMDs results in a penalty of 25% of the amount that should have been withdrawn.
This begs the question, what if you should have been taking such RMDs since the change in the law but haven't been due to the uncertainty mentioned above? Believe it or not, the IRS has waived the penalties to this point due to the confusion. However, now that the matter is settled, heirs will need to begin taking, starting in 2025, the yearly RMDs from inherited accounts under those final regulations to avoid the penalty.
Now, back to the conventional wisdom I mentioned above and how it may not be the best for you. At the moment, federal income tax rates are fairly low, historically speaking (at least in recent years). However, absent a law change occurring in the next year or so, these tax rates that came into effect via 2017 tax reform will revert to pre-2017 rates and brackets after 2025, which are generally higher.
What this means is that for many, putting off distributions could cost them money overall by subjecting the withdrawals to higher tax rates in future years than they would pay now. Of course, the ultimate tax rate that will be paid depends on many things, such as what other income you may have now versus then, and of course, what tax rates actually will be in effect after 2025.
Long story short, some planning and even income projections are necessary to determine whether you should consider taking more in inherited retirement account distributions now rather than later. Even so, it could be an exercise worth considering.
