The IRS Deals A Blow To Inherited IRAs And This Could Be A Trap For Many

by Retirement Advisor | Sep 19, 2022 | Inherited IRA | 1 comment

Up until 2019, IRA holders did not have to take money out of their IRAs – and pay taxes on those distributions – until they turned a certain age (which is currently 72 for those born after 1949) regardless of whether their IRAs were their own or inherited. Because of this, someone could name a beneficiary who was much younger – a grandchild, for example – and keep wealth untaxed for generations. This estate-planning technique was known as the “stretch IRA.”In 2019 the SECURE Act eliminated this benefit for those who inherited IRAs and were not spouses of the IRA owner. The new rule mandated a full withdrawal within 10 years of receiving it and thus closed a loophole that allowed an indefinite tax deferral. Still, the IRS gave considerable flexibility to the inheritor as to the timing of withdrawal within that decade. Therefore, with some planning, beneficiaries could try to minimize the tax consequences of those distributions, for example by taking them during years when income – and marginal tax rates – were expected to be lower. The IRS, however, published new rules in 2022 taking away much of that flexibility. For an IRA owner who died after 2019, non-spouse inheritors who are individuals are now required to take distributions annually and the whole amount by year 10. Distributions from an inherited IRA must be taken every year after the year of the owner’s death. The original IRA can take the first distribution in the year of death according to the age of the owner if the owner was already taking distributions, and then distribute the remainder to beneficiaries. The amounts of these annual withdrawals for each beneficiary depends on their age, similar tot he way the required minimum distributions are calculated for traditional IRAs. Note, however, that the table used for the calculation (Table 1 in publication 590-B) starts at the age of 0, so even new-born baby beneficiaries (who are not minor children of the owner) may have to take distributions and pay taxes if their resulting income is large enough. If the beneficiary is older than the original owner, the owner’s age during the year of death should be used. The entire amount has to be withdrawn within 10 years use the beneficiary’s age at the time, except when there are multiple beneficiaries. In that case, everyone would have to use the age of the oldest beneficiary – a rule designed to increase the IRS’ take. There is an exception to this rule (what would an IRS rule be without an exception?) which is that if the owner’s IRA was split into different IRA accounts before distribution and each one had its own beneficiary, then each one will use his or her own age. In all cases, whatever is left in the account by the 10th year will need to be distributed. There are many more twists to the new guidelines, for example if the owner dies before the date of required distributions, or the beneficiaries are trusts or they are not the spouse but fall in certain categories that provide exceptions.