IRS changes to the penalties tied to certain required minimum distributions are seriously confusing clients, advisors say.
Earlier this year, the IRS issued proposed regulations requiring non-eligible designated beneficiaries who are inheriting retirement accounts to take annual required minimum distributions during the first nine years of a 10-year period. Missed RMDs were subject to a 50% excise tax penalty. Now the IRS has said it will waive the penalty for certain missed 2021 and 2022 RMDs. But that too could change down the road.
“Clients are likely unaware of these proposed regs,” said Kelly Gillette, a Dallas-based Armanino tax partner in the client advisory section. “The proposed regs were related to inherited IRA accounts where the participant died after their beginning RMD date … requiring the annual RMD during the 10-year period.”
In February, the IRS issued proposed regulations indicating that designated beneficiaries subject to the 10-year rule may also be subject to an annual RMD requirement; a designated beneficiary’s RMD requirement would depend on the original IRA owner’s RMD requirement.
“The IRS proposed rule indicates that a designated beneficiary may be subject to both a 10-year distribution and annual RMDs,” said Megan Slatter, wealth advisor at Crewe Advisors in Salt Lake City.
“The problem we’re now encountering is … the impression that beneficiaries subject to the 10-year rule did not have to take an RMD for 2021 and 2022 and would now be subject to a 50% excise tax,” Slatter said.
Observers have noted that the latest IRS notice mentions a waiver of the penalty but doesn’t mention if the RMD requirement itself was waived.
“The IRS notice does not affect lifetime RMDs, inherited IRAs by eligible designated beneficiaries and RMDs by beneficiaries who inherited before 2020,” said Kristi Borglum, an advisor at Moneta in St. Louis.
“Some clients may already be taking a portion of the impacted inherited IRA each year to help minimize the tax implications of distributions more evenly,” she said. “Others, where it makes sense, may be deferring the distributions until a later date, potentially at the end of the 10-year period, if they anticipate being in a lower tax bracket in the future.”
“It’s vital to confirm what type of beneficiary someone is, because this will determine their available distribution options and eligibility for the IRS waiver,” Slatter added.
“First, you need to determine if someone is considered a designated beneficiary and subject to the 10-year rule,” she said. “Then you need to identify if the original owner died before or after their required beginning date. Finally, if someone is considered a successor beneficiary, there are additional layers of complexities to be aware of, including the designation class of the original beneficiary and if they were taking distributions based on their annual life expectancy.”