Urgent Action Needed to Protect Your IRA
Once upon a time, IRA distributions were relatively straightforward. Retirees would take distributions based on their life expectancy and that of their primary beneficiary. Distributions would have to begin no later than age 70-1/2, a number etched into our brains. Surviving spouses of deceased IRA owners could roll the IRA into their own. Non-spouse beneficiaries had the option to take distributions over their own life expectancies (so-called “stretch IRAs”). The only noticeable change to distribution rules occurred in 2006 when Congress began allowing charitable contributions directly from IRAs. With that one exception, IRA rules changed very little for decades, until recently.
Beginning in 2020, the SECURE Act introduced a number of changes. The most noticeable change was that the government now incorporated longer life expectancies into IRA distribution schedules, allowing RMDs to begin the year the IRA owner turns 72. Other favorable changes ushered in by this law included allowing employees age 70-1/2 and older to contribute to IRAs, and making part-time employees eligible to participate in 401k plans if they work at least 500 hours for three straight years (versus 1,000 previously).
However, that’s where the good news ends. Congress enacted a way to pay for the goodies in the SECURE Act by taking away “stretch IRAs.” Traditional and Roth IRAs must be emptied by the end of the tenth calendar year following the IRA owner’s death. Under the Act, the old rules would still apply to surviving spouses, minor children, the disabled, and non-spouse beneficiaries no more than ten years younger than the IRA owner.
This upended the estate plans of many investors. It was particularly angering to those who paid taxes to convert to a Roth with the promise of decades of tax-free growth and distributions even following their death. But at least beneficiaries had the flexibility to choose when to take distributions as long as the IRA was empty after the tenth year.
Hopefully you are sitting down because the news is about to get worse. The IRS has decided Congress didn’t mean that you could choose the timing of the full IRA distribution. Under its proposed rule, investors with inherited IRAs would now have ten years to completely empty the IRA, but with a minimum distribution required in each year.
I don’t know if Provident’s experience is typical, but 72% of our clients with inherited IRAs are younger than Social Security’s full retirement age with a median age of 57.5 years. This means most of them will be forced to take distributions from retirement plans before they are retired. Let that irony sink in for a moment. Rather than using the inherited IRA to help fund their retirement, presumably at a lower tax rate, they will have to withdraw funds while still working. These withdrawals will be taxed on top of their salaries, presumably at a higher rate.
Even if you’re not particularly bothered by this change, you should be after reading the following:
This comes from IRS Publication 590-B, “Distributions from Individual Retirement Arrangements (IRAs) For use in preparing 2021 Returns.” It is the authoritative IRS publication on IRA distributions.
Read that last sentence again. “The beneficiary is allowed, but not required, to take distributions prior to that date.” How could this be interpreted to mean anything other than what the words say? I must have missed the clause “unless the IRS changes its mind.” If doing away with stretch IRAs under the SECURE Act tripped up retirement savers, this new proposal must feel like an extra kick by the IRS just for good measure. Tar and feathers anyone?
Our only hope is that public comments come down heavily against this proposal, causing the IRS to change its position. The relevant part of the SECURE Act says that previous exceptions to the “5-year rule” no longer apply to beneficiaries other than surviving spouses, minors, and the disabled. The exception referred to allows for the payment of distributions over the lifetime of the beneficiary. The SECURE Act also changes the 5 to a 10. With the exceptions gone from the old law other than certain beneficiaries, all that is left is the new “10-year rule.”
Honest debate needs to include alternate points of view. One is a little matter of the original law saying “the remaining portion of such interest will be distributed at least as rapidly as under the method of distributions being used under subparagraph (A)(ii) as of the date of his death.” The problem is that subsequent interpretations in place for decades included methods of distribution that were less rapid than the original law required. Why should the IRS change back to an old interpretation now?
You have a right to make comments regarding pending government rules. If you feel this change would harm your interests or is simply unfair, here’s what we need you to do. Go to:
https://www.regulations.gov/CommentOn/IRS-2022-0003-0001
In particular, cite that IRS Publication 590-B interpreted the new 10-year rule to mean the beneficiary has the right to take distributions before the tenth anniversary of the IRA owner’s death, but is not required to do so. This is how investors and accountants interpreted the provision of the SECURE Act prior to IRS guidance published on February 24, 2022. The SECURE Act already accelerated distributions compared to prior methods that were in place for decades and that were relied on by investors when planning their retirement savings. To accelerate them even further undermines public confidence in the reliability and consistency of rules around which investors plan their financial futures.
Comments are due by May 25th for a hearing scheduled for June 15th.
Scott D. Horsburgh, CFA