Just like the weather in Rochester, financial regulations are ever changing. Two recently proposed changes could upend your plan for drawing money from inherited IRAs and how you save in your 401(k) if they are approved later this year.
The Secure Act put new regulations in place in 2019 for drawing money from inherited retirement accounts, but the IRS just issued new “guidance” that could further change those rules. The 2019 law eliminated the ability to draw money out of inherited retirement accounts over the course of the beneficiary’s life expectancy, the so-called stretch option. Rather, these accounts had to be fully drained over a ten-year period, with a few exceptions for spouses, someone less than 10 years younger than the decedent, a disabled individual, and a delay for minors until they reach 21. The vast majority of the time, this would result in larger draws from qualified retirement accounts, which results in greater tax liability.
The biggest reason for the change, unsurprisingly, was that it would raise revenue for the Treasury by accelerating taxable distributions. The Joint Committee on Taxation estimated that the elimination of the stretch option will raise an additional $15.75 billion in federal revenues from 2020 through 2029.
Even with the 2019 rules, retirement plan beneficiaries had the flexibility to take money out of their inherited retirement accounts at any time over the subsequent ten years. It could be one tenth each year, all up front, all in year ten, or any other permutation. You could decide what was most beneficial to you based on your financial needs and tax circumstances.
However, the new guidance reduces this flexibility by requiring inheritors of accounts whose original owner died after they started taking required minimum distributions (RMDs) to take at least some money each year. The annual distributions have to be at least as much as the original account owner’s RMDs would have been. Nevertheless, the full balance of the account still has to be distributed within the ten-year period, even if the RMDs don’t get you there.
If the original account owner had not yet started RMDs, then no annual draws are required for beneficiaries, but the account must still be fully distributed within ten years. Similarly, Roth IRAs may be liquidated however the beneficiary chooses over the ten-year period.
Think this is confusing? Wait, there’s more.
A bill passed by the House of Representatives could change the way you contribute to and draw from your 401(k) plan and other retirement accounts. The Secure Act changed the age for RMDs from 70 ½ to 72, and now that age may be raised even further, to 73 next year, 74 by 2030, and 75 in 2033. There would also be a boost in catch-up contributions for some. Currently those over age 50 may contribute an extra $6,500 annually to their 401(k) plans. The new bill would allow those aged 62, 63, or 64 $10,000 in catch up contributions starting in 2024. Though, the catchup would have to be done with after-tax dollars in a 401(k) with a Roth provision. Further, all catchup contributions for anyone over 50 would need to be done in Roths after 2023.
Some of this is good news, as it builds in more flexibility. Much of it is bad news, as it accelerates the taxes you will owe on retirement account balances. However, all of it further complicates tax planning for retirement account owners and their beneficiaries. Depending on your circumstances, it may mean that IRA owners should accelerate some of their distributions before their RMD age, convert balances to Roth IRAs, or delay draws to the extent possible in order to reap the greatest benefits across generations. As always, we are happy to talk through the details of your situation to help minimize the tax bite and optimize your retirement savings.
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