By Theresa Cagle Fry, Senior Vice President and Manager, IRAs, Retirement & Education Planning
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Paying taxes can be scary enough, but layer on top of that a 50% IRS tax penalty and the results can be horrifying. That’s what can happen if you don’t take required minimum distributions (RMDs) when you inherit retirement accounts.
One of the benefits of saving in a retirement account is tax deferral. Beneficiaries who inherit IRAs or workplace retirement plans, like a 401(k), are only able to continue deferring income taxes on the retirement account savings for a limited time after the original saver dies.
Year of Death Distributions
In the year a retirement account owner dies, if the decedent was required to take distributions, beneficiaries who inherit those accounts must take any remaining outstanding RMD amount before the end of the year. This can sometimes come as a surprise to beneficiaries, especially if their loved one died late in the year.
For example: If Virginia dies at age 85 in October 2022 and she had a 2022 RMD of $20,000 that she had not yet taken from her IRA prior to her death, her beneficiary, Julia, must take the $20,000 RMD by Dec 31, 2022, from the inherited IRA. In this example, it is Julia that receives the RMD and must include the $20,000 distribution in her taxable income for the year (not the decedent Virginia).
New Regulations Provide Some Relief for Missed Year of Death Distributions
Regulations proposed earlier this year by the IRS provide relief for the 50% IRS penalty tax in situations where a year of death distribution is missed by an inheriting beneficiary. If distributions that were otherwise required to be taken by Dec 31 are taken by the beneficiary no later than their tax filing due date (including extensions), the 50% penalty will automatically be waived. That’s good news!
For example: If Julia neglected to take Virginia’s $20,000 RMD by December 31, 2022, she will avoid a $10,000 tax penalty as long as she distributes the $20,000 RMD by April 15, 2023.
RMDs Required After the Year of Death
The new proposed regulations also provide guidance and interpretation for distributions required after the year of death if the account owner (or the prior inheriting beneficiary) died after 2019. If you inherited from a retirement account owner (or prior beneficiary) before 2020, these new regulations do not apply to you. However, if you inherited from an account owner or prior beneficiary who died in 2020 or later, you’ll want to review your situation with your accountant or CPA. They can provide advice to you about how these proposed regulations impact your income taxes and may discuss some planning opportunities for you regarding how you should take the distributions.
Updated Life Expectancy Tables for 2022 RMDs
For years after the account owner’s date of death, annual RMDs, if required, are calculated using the prior year end account balance divided by a life expectancy. In most cases, the life expectancy used is the single life expectancy of the beneficiary that inherited the retirement account. However, there are exceptions that apply where the life expectancy used could be that of the decedent or of a prior beneficiary. For 2022, the life expectancy tables used for calculating RMDs were updated to reflect longer life expectancies. All beneficiaries will use these new tables when calculating their 2022 RMDs. That is also good news because longer life expectancies will lower the RMDs.
If you have recently inherited an IRA or 401(k) plan from a loved one, don’t make the mistake of forgetting to take your required distributions. Talk to your financial advisor if you would like to review your retirement savings accounts or receive additional information about RMD changes this year.
Benjamin F. Edwards does not provide legal or tax advice, therefore it is also important to consult with your legal and tax professionals for additional guidance tailored to your specific situation.