Could It Affect Your IRA?
A retirement savings expert says he is “100% convinced” the IRS made a mistake and will have to correct it soon.
Ed Slott, a well-respected IRA distribution expert, says IRS guidance issued in March likely mischaracterized how those who inherit an IRA are required to pay taxes on the money they receive.
The alleged error stems from a 2019 change in federal law that eliminated the so-called “stretch IRA.”
As we have reported, the Setting Every Community Up for Retirement Enhancement (Secure) Act of 2019 shifted the rules for inherited IRAs. Prior to the law, those who inherited retirement money from accounts like IRAs could “stretch” withdrawals — and thus spread out the taxes due on the withdrawals — over their lifetime.
The Secure Act changed that by requiring that many who inherit an IRA or other retirement plan to withdraw the money, and pay taxes on it, within 10 years. There are exceptions to the rule — such as for spouses — but in general, many of those inheriting an IRA now can expect to pay more in taxes on their inheritance than they would have in previous years.
All that appeared to be straightforward when the Secure Act was passed in 2019. But in March 2021, the IRS issued guidance that muddied the waters.
“On Page 12, the publication states with an example that under the 10-year rule, there would be RMDs for years one through nine, before complete depletion at the end of the 10-year post-death period. No one believes that to be correct, including many experts we have contacted on this.”
Instead, Slott maintains that the new 10-year rule is likely to work in the same way as the “five-year rule,” which is used in a different circumstance — namely, when there is no designated beneficiary and the IRA owner dies before age 72, the age when retirees generally must begin taking RMDs.
Under the five-year rule, those who inherit an IRA are not required to take distributions until the end of the five-year period if they so choose.
By contrast, the IRS guidance on the 10-year rule suggests that those who inherit an IRA will be required to take distributions at the beginning of the 10-year period. This is where Slott believes the IRS made a mistake.
Why the alleged mistake matters
If Slott is right, then a correction is likely coming soon, and it could have implications for some people who inherit IRAs.
As Slott points out, being allowed to tailor withdrawals to your own financial situation — instead of being required to make RMDs every year over a decade — could help those who inherit IRAs better manage and reduce their tax burden:
“This would provide planning flexibility in years one to nine, allowing distributions to be adjusted to tax brackets in those years. This was also a benefit for inherited Roth IRAs, where nothing would have to be withdrawn from the inherited Roth IRA until the end of the 10th year after the death, allowing 10 years of tax-free buildup before the Roth funds would have to be withdrawn.”
Time will reveal whether the IRS made a mistake and corrects it. Slott says he has heard that privately, the IRS acknowledges the blunder and will make a correction.
Slott also says he found an additional clue that further supports his belief that the IRS is in error: A statement on Page 12 of the IRS guidance that shows the five-year and 10-year rules are supposed to work the same way, with neither requiring distributions until the end of the five- or 10-year period.
“There is a direct contradiction here which convinces me that the idea of annual RMDs under the 10-year rule is just one big mistake that needs to be corrected.”
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