Money Talk: IRS extends excise tax relief for missed RMDs
As part of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, Congress changed the rules for how required withdrawals from retirement accounts had to be managed by beneficiaries who are not the retirement account owner’s spouse. While many of the Act’s provisions were positive for current and future retirees, there was one giant take away that has the potential to significantly increase the tax liability and accelerate its payment timing for retirement account beneficiaries. This change also created substantial confusion, enough so that the IRS waived penalties related to this change and recently extended this waiver through 2024.
Under the prior rules, non-spouse beneficiaries had to start taking required minimum distributions (RMDs) from inherited retirement accounts in the year after the original account owner’s death. While this triggered additional taxable income that was unavoidable, the good news was that these distributions could be kept relatively small by stretching them over the beneficiary’s life expectancy. In this way, the tax deferral benefits of traditional, pre-tax retirement account could be preserved for a long time in many cases, perhaps for generations.
The SECURE Act effectively killed this “stretch IRA” concept by limiting the withdrawal window, requiring that inherited IRA and employer plan accounts be emptied by the end of the tenth year after the original account owner’s death. This 10-year rule also applies to successor beneficiaries of inherited IRAs from which the primary beneficiary was taking life-expectancy withdrawals.
Initially, most tax planners equated this new 10-year rule to the existing 5-year rule that applied to tax-deferred account withdrawals in certain situations. This rule simply required that the account be fully disbursed by the end of the fifth year after the owner’s death. Annual withdrawals were optional. The beneficiary could elect to spread the withdrawals across the five-year period, skip years, or wait until the fifth year to take any money from the inherited account, whichever made the most sense for their tax situation and financial goals.
The IRS had a bit different interpretation of Congress’ intent with the new 10-year rule. Instead of allowing for withdrawals to be deferred until the tenth year, the IRS interpreted the SECURE Act to require that beneficiaries take required withdrawals annually if the original account owner had already started taking RMDs. The beneficiary could use their own life expectancy to determine their RMD amount and the life expectancy factor is determined using the IRS’ Single Life Expectancy table. When the original account owner had not yet reached the age at which their own RMDs kicked in, the 10-year rule works just like the 5-year rule. No withdrawals are required until the tenth year, but beneficiaries can certainly take withdrawals from the inherited retirement account if appropriate for their tax situation and financial goals.
The problem with the IRS’ interpretation of how the 10-year rule applied when original account owners had begun taking RMD’s is that it came out after the first group of new IRA beneficiaries (those inheriting accounts after 2019) should have taken their first required withdrawal. Since the penalty for missing an RMD is 50% of the amount that was not taken, it is not surprising that the IRS’ rule received plenty of negative feedback. Consequently, the IRS granted a waiver of the 50% excise tax that would have applied to missed RMDs in 2021 and 2022. This relief was extended to tax year 2023 and was just extended again for 2024 per IRS Notice 2024-35.
For future tax years, beneficiaries who inherited retirement accounts after 2019 should plan on annual withdrawals if the prior account owner was taking required distributions. The good news is that the penalty for coming up short on an RMD has been reduced from 50% to 25% by a subsequent SECURE Act (SECURE 2.0). The penalty can be reduced further to 10% if the missed required withdrawal is corrected within two years.
If you already took a required withdrawal for 2024 thinking that failure to do so would trigger the excise tax, it is not possible to utilize the 60-day rollover rule to get the funds back into the inherited IRA. If you did not traverse several tax brackets with the withdrawal amount, you may have done yourself a favor by taking some funds out before you needed to, leaving less to be withdrawn in year ten.
David T. Mayes is a CERTIFIED FINANCIAL PLANNERTM professional and IRS Enrolled Three Bearings Fiduciary Advisors, Inc., a fee-only advisory firm in Hampton. He can be reached at (603) 926-1775 or david@threebearings.com.
This article originally appeared on Portsmouth Herald: Money Talk: IRS extends excise tax relief for missed RMDs
