Changes to inherited IRAs
In 2010, taxpayers took a total of $9.2 billion inherited IRA distributions. The average distribution was $5,578. Those numbers will be much higher today. Our population is older (more people will be passing) and the total value of IRA assets has grown to $13.2 trillion, an increase of $8 trillion.
What is an inherited IRA? When someone other than your spouse makes you the beneficiary of their IRA, Roth IRA or 401(k), by IRS terms your account becomes an inherited IRA.
The rules on inherited IRAs were changed in the 2019 Secure Act, which introduced a new 10-year payout rule for inherited accounts. Prior to those who inherited an IRA, Roth IRA or 401(k) could spread out withdrawals over their lifetime. Tax professionals believed this rule meant payouts could be postponed for 10 years.
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. As of today, the Secure Act requires required minimum distributions (RMD) to begin at age 72. If someone other than your spouse left you an IRA and they were over the age of 72, you must begin taking annual withdrawals now.
Remember, this new IRS guidance will now require some individuals to take out the money earlier, instead of waiting for retirement when the money might truly be needed. The new guidance means that many Americans inheriting an account will inherit it during their working life.
Inherited IRAs are taxed like wages. This could result in individuals paying a must larger tax bill.
Understand that the Secure Act passed by Congress is a law. A new interpretation of that law that increased taxes is a tax increase unapproved by the Legislature. It is not a tax on the wealthy. Remember average distribution was $5,578.
If you inherit a Roth IRA you do not have to take pay-outs until the end of the 10-year period because Roth IRAs do not have annual RMDs.
If this sounds confusing it is. My hope is to make you aware that if you can’t wait 10 years to touch an inherited IRA. If you do wait, you can be penalized.
When faced with complex financial decisions such as this, many people will simply take the money and pay the tax. While that might accomplish the IRS goal of more revenue, it is rarely in the best interest of you, the beneficiary.
There is a possibility that Congress could clarify the law. On the other hand, the IRS has received online comments from taxpayers and industry groups including the American Institute of Certified Public Accountants urging the IRS to stop the additional annual distribution requirements.
As always, reach out to your tax professional and get the most current advice on how to manage an inherited IRA.
Bob Hollick is a State Farm Insurance agent based in Washington. His column appears every other Friday in the Observer-Reporter.