Did you inherit an IRA? What you need to know about new IRS rules for your financial plan

If you recently inherited an IRA or stand to, this is for you. The complexities of an inherited IRA (or individual retirement account) is a hot topic right now among financial planners, estate attorneys and tax professionals. Forthcoming changes to IRS rules for heirs may significantly impact your financial plan. 

The part of the new IRS SECURE Act causing the most reaction is necessitating annual required minimum distributions (RMDs) for some IRA or workplace plan beneficiaries subject to  the 10-year payment rule.

Financial planning professionals at Ballast Advisors share what you need to know.

Withdrawing an inherited IRA

When you inherit an IRA, or other qualified employer plan, you have choices on how to handle it.  Ultimately payouts from a traditional inherited IRA (also known as a beneficiary IRA) are taxed by the federal government and by most states , so if you are a beneficiary, how and when you choose to distribute inherited funds is often a strategic decision.

Was the owner your spouse? Are you a minor child? Do you qualify for disability or have a chronic illness? Is it a traditional IRA or Roth IRA? These individual variables, such as type of plan, the type of beneficiary, and the age of the account owner at death, are all determining factors for how and when to take IRA withdrawals to stay within the inherited IRA withdrawal rules.

“Depending on the circumstances, one may choose to rollover an IRA, to take a lump sum payout, or take the required minimum distributions or RMDs. Some clients may even choose to disclaim the funds, allowing them to pass on to another individual or entity,” says Rich Gerczak, a financial planner with Ballast Advisors in Arden Hills, MN.

Rules for inherited IRA payout guidance changes

For beneficiaries who choose RMDs, the important changes to the rules revolve around the timeframe for required minimum distributions.

We have made plans for our clients regarding the past tax laws and the uncertainty on the new laws have made it difficult to plan accordingly,” Gerczak explains.

The SECURE Act in 2019 introduced a new 10-year payout rule for heirs of an IRA, and guidance from the IRS in 2021 in Publication 590-B, stated the payouts could wait until year 10. 

However updated IRS guidance released in February, suggests it would now require heirs to take annual withdrawals, in cases where the original owner died on or after his/her required beginning date for taking distributions. 

Although the decision has not yet to be finalized, as noted in a recent Wall Street Journal article, the potential change is vastly complicating matters for clients and financial professionals who have made financial plans based on interpreting the 10-year rule to mean that these heirs could wait until the 10th year before taking any payouts.

“The differences between interpreting the law may seem small, but from a financial planning perspective, it can make a world of difference on the taxes paid and how much a client is able to keep,” adds Gerczak.

Avoiding penalty on an inherited IRA

Navigating tax strategies for generational wealth is nothing new, however the complexities surrounding inherited IRAs is a good example of the intersection of estate planning, financial planning and tax planning. A wrong decision could lead to expensive consequences. If you don’t get it right, you could receive a penalty equal to 50% of what the IRS says you should have withdrawn.

“Because the  50% penalty is so punitive, getting it right is critically important.   You don’t want to make a mistake,” advises Gerczak.

Taxpayers can deal with the new law and guidance by calculating the necessary amount each year. Or, they can cash out in the first year and pay one tax bill.

A financial plan for multigenerational wealth

There is more than $12 Trillion currently sitting in IRAs. Even if this rule change doesn’t apply to your financial plan right now, the changes will inevitably impact Gen X, Millennials and Gen Z’ers who stand to inherit a significant portion of these dollars in years to come.

Whether you are hoping to pass on wealth as a part of your legacy, or you stand to inherit someone else’s, it’s important to stay current with tax laws and review these matters with your financial planner and other planning professionals.

Sources:

https://www.schwab.com/ira/inherited-ira/withdrawal-rules
https://www.irs.gov/publications/p590b
https://www.forbes.com/advisor/retirement/inherited-ira-rmd-rules/
https://www.wsj.com/articles/irs-changes-guidelines-for-inherited-iras-causing-confusion-and-pushback-11659309278
Publication 590-B 2021

IMPORTANT DISCLOSURES The opinions expressed herein are those of Ballast Advisors, LLC and are subject to change without notice. The third-party material presented is derived from sources Ballast Advisors consider to be reliable, but the accuracy and completeness cannot be guaranteed. Past performance is not indicative of future results. Nothing contained herein is an offer to purchase or sell any product. This material is for informational purposes only and should not be considered investment advice. Ballast Advisors reserve the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. Ballast Advisors, LLC is a registered investment advisor under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about the firm, including its services, strategies, and fees can be found in our ADV Part 2, which is available without charge upon request.