Pension plan heirs get tax relief from IRS

Recent heirs to pension plans received an unexpected boost when the Internal Revenue Service suggested they could skip required withdrawals for this year and last, a reprieve that eliminates one-time tax hits and leaves more money in a nest egg to grow.

The tax authority surprised wealth management advisers late last Friday when it announcement that people wouldn’t face a hefty 50% penalty for not taking minimum distributions from legacy plans, such as Individual Retirement Accounts, for 2022 and 2021. Although the IRS didn’t specify the things straight and said the final rules would come next year, the announcement seems to mean heirs are definitely off the hook for withdrawals for those two years.

“The IRS is now saying that there will be no 50% penalty for not taking these RMDs, which seems to me to mean that these RMDs should not be taken (even if the IRS has not specifically stated in the notice),” said Ed Slott, a chartered accountant and retirement expert at Rockville Center, New York.

The news has rattled estate planners just as the annual rite of required minimum distributions, or RMDs, kicks in for millions of Americans amid a recent shift in how retirement plans are passed on to heirs. Under a 2019 law, beneficiaries who are not spouses, minor children, chronically ill, disabled or no more than 10 years younger than the plan owner must empty inherited accounts, whether they either traditional or Roth, within 10 years. Previously, heirs could “spread” withdrawals over a lifetime. The law hits beneficiaries of inherited plans whose original owner died after 2019.

Withdrawals from traditional IRAs and 401(k), whose contributions are made with dollars on which taxes have not yet been paid, are taxed at ordinary rates, now above 37%. Failure to make a minimum withdrawal, also known as taking a distribution, triggers an annual 50% penaltyplus interest, on the minimum amount not withdrawn.

The earlier “expandable” system was a key tool for increasing wealth because it allowed assets to grow in value over a longer period. A separate law canceled all RMDs of defined contribution plans, including legacy plans, for 2020, in the context of the COVID-19 pandemic. Combined with the two-year reprieve, some heirs won’t have to take three distributions over 10 years.

This means more money can accumulate over a decade. But it can also create what Scott Bishop, executive director of wealth management solutions at Avidian Wealth Solutions in Houston, has called a “tax ticking time bomb,” in which heirs once pay larger tax bills because that they have to withdraw larger amounts over a shorter period of time. The Roth heirs’ plans, which are funded with dollars on which taxes have already been paid, owe no tax on withdrawals, but they still have to make annual ones and empty the accounts within 10 years.

The 10-year rule is a major change for the estate planning industry. But the IRS has flip-flopped on how it will work, and even with the new reprieve, it still hasn’t issued final rules. Those are still to come, the agency said in its Oct. 7 statement. to remarkand they “will apply at the earliest in 2023, he said.

“Do not confuse…”
What is clear for now in the IRS reprieve is that heirs who are not a surviving spouse, chronically ill, disabled, or child do not have to make minimum withdrawals this year. and last before emptying the accounts within 10 years. Although spouses, sick people and children must still take the required annual distributions, including for 2021 and 2022, they can do so during their lifetime; a child is hit by the 10-year rule once they turn 18.

“With this recent IRS drop, we now know that we don’t need to have taken the 2021 RMD and we won’t need it for 2022,” Bishop said. He sent clients a note Oct. 10 saying, “Do NOT confuse this with BEFORE 2020 Inherited IRAs, where RMDs ARE still required annually for beneficiaries based on their life expectancy.

Timothy Steffen, director of tax planning at Baird in Milwaukee, said “the really big news” in the notice is that beneficiaries who are trusts, estates and charities are off the hook for withdrawals for 2021 and 2022.

RMD Basics
The federal government wants to make sure it gets tax revenue from retirement savings and that people don’t accumulate massive accounts that pass tax-free to their heirs. It therefore requires owners of non-inherited IRAs, 401(k), and other defined contribution plans whose tax bills are deferred until withdrawals are made, to withdraw a minimum each year once they reach the age of 72, whether they are retired or still. work.

Taxpayers must generally take a first distribution before April 1 of the year after they reach the age of 72. No annual withdrawal is required for original, living owners of Roth plans, as they are funded by dollars on which taxes have already been paid. A 2019 law raised the age at which taxpayers must make their first withdrawal for 72 of 70½ — although taxpayers born before 1 July 1949 are subject to the lower age limit.

Seniors who ignore “the Great Resignation” and who are still employed and contributing to an employer-sponsored retirement plan can delay a first withdrawal from that account – but not from others – until April 1 after retirement, according Loyalty investments.

The minimum amount to withdraw is calculated dividing the balance at the end of the previous year by what the IRS calls a “life expectancy factor.” With markets in sharp decline since the end of 2021, the calculations risk hurting millions of taxpayers, who will have to withdraw more from their plan than expected and pay taxes on the withdrawal.

Withdrawal amounts start at approximately 3.5% per year and increase as the taxpayer ages, according Personal Capital Advisor, an independent wealth management firm in Redwood City, CA. So a 72-year-old man with an IRA worth $500,000 at the end of last year would need to withdraw just over $18,200 for this year, or just over 3.6%, according the American Association for the Advancement of Retired Persons.

If that IRA is invested in the S&P 500, which is down just over 24% so far this year, it’s worth just $380,000 and the withdrawal is now 4.8% of the nest egg – close to the upper end of the 4% to 5% of the fidelity range said retirees can safely draw without worrying about running out of money.

Flip flops
The 2020 pause on distributions was clear. But wealth advisors have been left in the dark about the RMDs of legacy plans for 2021. That’s because the IRS has changed his mind so many times on the issue.

In early 2021, the agency said annual withdrawals would be required in years one through ninth before an inherited account would be emptied in year ten. Then, months later, she said otherwise. Last February, he shocked advisers and accountants by saying he had made a mistake and that annual distributions were, in fact, required from the first to the ninth year.

But because this latest proposal was a proposal, not a finalized rule, advisers weren’t sure if they should tell heir clients to withdraw for 2021. The Oct. 7 notice makes it clear they didn’t. not have to do it for that. year or for 2022. But also left open is a scenario where heirs could be forced to make taxable “catch-up” withdrawals by the 10th year.

“I suppose that opens up the possibility of them being delayed beyond 2023, but that doesn’t seem likely,” Steffen said.

For many advisors, the ongoing uncertainty is straining estate planning techniques that have been used for decades. The The IRS is the subject of fierce criticism and lobbying by the tax and wealth management industries to clarify the rules of the road.

“This RMD confusion is still an evolving process,” Slott said. “The IRS has issued this interim fix, but final regulations are coming and may contain more changes.”