The IRS announced late Friday that there will be no excise tax penalty on missed required minimum distributions (RMDs) of inherited IRAs for tax years 2021 and 2022. Final rules of what amounts to an unexpected tax reprieve for some people who inherited retirement plans such as IRAs, will be disclosed next year.
Consider working with a financial advisor as you develop a retirement plan.
The 10-Year Rule
The Secure Act of 2019, enacted Dec. 20, 2019, eliminated the “stretch IRA,” which let heirs extend distributions from inherited IRAs over their entire lifetimes. The effect of the 2019 law was that non-eligible designated beneficiaries, meaning non-spouses, minor children, chronically ill or disabled people and some trusts, had 10 years to withdraw the entire balance of the inherited account. In cases where inherited retirement plans were particularly large, it left beneficiaries with a huge tax bill.
In other words, if you skip RMDs or only take part of the obligatory RMD by the deadline there is a 50% penalty that gets applied to what was supposed to have been distributed. The 10-year rule applied to retirement accounts inherited after Dec. 31, 2020.
Confusion, Then Clarity
When proposed regulations were issued in February to implement the new law a number of beneficiaries believed that, regardless of when an employee died – whether the employee had begun taking RMDs or not – the 10-year rule would not require any RMD due for a calendar year until the last year of the 10-year period following the death of the employee.
The IRS said many heirs or beneficiaries of individuals who died in 2020 admitted not taking an RMD in 2021 and were unsure whether they would be required to take an RMD in 2022. The concern has been that if final regulations adopt the interpretation of the 10-year rule set forth in the proposed regulations, the Treasury Department and the IRS should provide transition relief for failure to take distributions that are RMDs due in 2021 or 2022.
“To the extent a taxpayer did not take a specified RMD, the IRS will not assert that an excise tax is due under section 4974,” the agency said Friday. “If a taxpayer has already paid an excise tax for a missed RMD in 2021 that constitutes a specified RMD, that taxpayer may request a refund of that excise tax.” The IRS, in other words, stated that the proposed regulations will not apply until 2023.
Retirement plan beneficiaries and people who inherited IRAs have been asking for clarification on whether the proposed regulations means they should have taken RMDs in 2021 and 2022. Friday’s announcement by the IRS means that retirement plan heirs won’t get hit with a huge tax so money in the plan can continue to grow. It also gives advisors and their clients more time to create or modify retirement plans.
Tips on Retirement
- How to handle RMD obligations can be challenging. That’s where a financial advisor can offer valuable insight and guidance. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Check out our no-cost retirement calculator for a quick estimate of how much you can expect to have in retirement.
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