If you have inherited an IRA, you need to be aware of the recent changes the IRS has made to the rules governing it. When it comes to required distributions for inherited IRAs you must be sure you understand the rules. They’re about as clear as mud and require proper navigation. Ashlea Ebeling reports for The Wall Street Journal:
Figuring out the most efficient way to navigate the tax impact of inheriting individual retirement accounts has become more complicated since the Internal Revenue Service issued proposed new rules in February.
The rules on inherited IRAs were most recently changed in the 2019 Secure Act, which introduced a new 10-year payout rule for inherited accounts. The previous rule said those who inherited an IRA, Roth IRA or 401(k) could spread out withdrawals over their lifetime.
Many tax professionals interpreted the new 10-year rule to mean that these heirs could wait until the 10th year before taking any payouts, and that is what the IRS said in a May 2021 revision to Publication 590-B, a 69-page guide to IRA distributions. But then, in February, the IRS issued new guidance that would require heirs to take annual withdrawals in cases where the original owner died on or after his required beginning date for taking distributions.
The annual distributions are based on a formula that takes into account the IRA balance and the age of the recipient. The new guidance also applies to 401(k)s, but with those plans, employers often already set even more restrictive payout rules.
Payouts from a traditional inherited IRA are taxed like wage income. The new guidance means that many Americans inheriting an account will inherit it during their working life, and will therefore pay a much larger tax bill, say accountants.
“It’s just horribly complex,” says Michael Jones, a certified public accountant in Plymouth, Minn., who wrote a book in 2014 about the tax benefits of stretching out inherited IRA payouts.
Taxpayers can deal with the new law and guidance by calculating the necessary amount each year. Or, they can cash out in the first year and pay one tax bill. Taxpayers who fail to take a required distribution are hit with a tax penalty that is equal to half the amount that should have been taken out.
“Maybe just go ahead and take that vacation in France,” says Mr. Jones.
Action Line: For more on vacations in France, read my series about Paris here. If you need help with your IRA, get in touch with me here. And if you want to get to know me better before we talk, click here to sign up for my free monthly Survive & Thrive letter. I’ll send it to you each month to keep you motivated to reach your goals for personal and financial security.