A proposal to require annual payouts from inherited retirement accounts is upsetting every corner of the retirement industry.
It all began last February, when the Internal Revenue Service jolted financial planners by introducing a potential rule for a recent law under which heirs must drain those accounts within 10 years. Under its proposal, the tax agency said that heirs would be required to take minimum distributions in years one through nine.
It was an about-face from the IRS’s
Now some heirs are facing potentially hefty tax bills and penalties. Required minimum distributions, or RMDs, are taxed at ordinary rates, now a top 37% for the highest earners. Under current law, investors who fail to take a full payout in a given year face a costly penalty equal to 50% of the unwithdrawn amount.
In recent months, ordinary Americans, accountants, lawyers, trade groups and plan sponsors and administrators filed
The 10-year rule
The agency’s contested proposal stems from a major law passed in 2019 that changed how tax-deferred retirement accounts are passed on to beneficiaries.
Under prior law, heirs used to be able to “stretch out” required distributions from IRAs and 401(k)s over their lifetime. That meant they could leave more money in the accounts to compound over time and pay the tax bills later.
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The SECURE Act of 2019 ended those “stretch” IRAs and 401(k)s by requiring heirs to empty them out by the end of the 10th year after the death of the original owner. The law applies to beneficiaries of accounts whose owner died on or after Jan. 1, 2020. Heirs who came into possession of an account earlier were grandfathered. The only exceptions to the 10-year rule: if an heir is a spouse, a minor child, disabled, ill or not more than 10 years younger than the account’s original owner. Once a minor child reaches the age of majority — which is usually 18 but can range to 21, depending on the state they live in — they fall under the 10-year rule.
Things can get tricky in other ways. If a beneficiary inherits an IRA seven years after the original owner died, perhaps because that heir was very young or the account was held in a complicated trust, then she has only three years to drain it,
The new law also raised the age at which savers must take RMDs from retirement plans, to 72 from 70 ½ (it stayed the latter for people born before July 1, 1949). While owners of
Say what?
Many retirement savers appear unaware of the IRS proposal’s annual payout requirement for inherited plans and assumed they could wait until year 10 to empty the accounts. The issue was made more confusing when lawmakers
LeeAnn Buckner
Many younger investors are going it alone to “buy the dip” and banking on a quick rebound, rejecting professional advice amid major market volatility.
Eleanor Speelman, who submitted three letters,
The American Bankers Association
‘Friction’
Policy experts and lawmakers are worried about Americans’ readiness for retirement, especially as people live longer. Fidelity Investments
The IRS proposal doesn’t help things, according to critics. Putnam Investments
Ed Slott, a certified public accountant in Rockville Centre, New York, said that “the whole 10-year rule is a gray area — where’d they pick that out?” An IRS spokesman declined to comment and said he was uncertain if the June 15 hearing would be in person or virtual. It can take months to finalize a proposed regulation.
Slott added it was possible the flood of criticism would carry weight at the tax agency. “It may be,” he said, “they’re seeing a lot of comment letters that will change their minds.”