Retirement advisers are reeling this week after the IRS proposed new regulations governing how and when savers are required to begin drawing down their inherited account balances.
The proposed rule (RIN: 1545-BP82) implements a 2019 law raising the age 401(k) and individual retirement account holders must begin taking required minimum distributions. It gives plan participants an additional year and a half to build up their savings tax-free.
But industry observers say the 275-page proposal increasing the minimum distribution age to 72 threatens to complicate an already complex and confusing area of the tax code by reversing course on guidance the Internal Revenue Service has already issued for plan beneficiaries who inherit an account.
“These rules generally affect older people, and the last thing they need is more complexity in their lives,” said Ed Slott, president of Ed Slott and Company LLC and a leading thinker in retirement distribution tax advice. “Simply put, this is too much for this group of people.”
The new IRS proposal backtracks on earlier guidance the agency issued, and then corrected last year, detailing how long certain retirement plan beneficiaries would have to clear out the savings they inherited. The back-and-forth nature of rule is raising alarms among financial advisers who say they don’t know what to tell their clients about inherited accounts anymore.
Most beneficiaries, other than spouses or young children, who inherited a savings balance after the deceased plan participant had already triggered required minimum distributions would have to keep taking those annual distributions for a period of nine years, according to the proposed rule. At the end of the 10th year, those non-eligible designated beneficiaries would have to clear out the entire account balance and pay taxes on the full amount.
Requiring annual distributions is contrary to congressional intent, said Slott.
“I think this is a real mistake,” he said. “All along, we’ve been under the impression that there would be no required minimum distributions from years one through nine.”
And for good reason. The IRS said as much in tax form guidance it published in May. Two months earlier, the agency had said all inherited accounts would have to take minimum distributions. The later pronouncement corrected that guidance to say money could stay in an account until the end of the 10th year.
Now the agency has taken a different, nuanced approach that requires distributions only if the deceased plan participant had reached the RMD age before their death.
“It’s beyond unnecessarily complicated at this point,” said Jeffrey Levine, chief planning officer at Buckingham Strategic Wealth LLC in St. Louis. “It will mean that Congress didn’t get rid of any rules applying to people in these situations; it just added more.”
Last year’s 10-year rule snafu and the course correction proposed this week overshadows a simmering debate over how much tax-advantaged retirement intricacy is too much.
Already this year, the IRS adjusted the life expectancy tables it uses to calculate how much money account holders have to take out annually. Meanwhile, Congress is considering legislation to increase the minimum distribution age once more.
Some financial advisers such as Slott say minimum distributions have outlived their purpose. Delaying required minimum distributions leaves participants and beneficiaries with increasingly unpalatable tax liabilities. But required distributions are congressional revenue-raisers, offsetting the cost of other proposals meant to bolster retirement savings overall.
The complexities put a strain on professionals who follow the IRS’ annual distribution twists and turns carefully and are nearly impossible for average consumers to keep up with, said Levine.
It has cost the government money, too. A 2015 Treasury audit identified more than half a million IRA participants or beneficiaries who missed compulsory distributions, depriving the U.S. of more than $100 million in revenue. The audit didn’t address 401(k) or 403(b) plans. The department recommended a more comprehensive reporting program and less complex rules.
Perhaps more importantly, said Levine, the cost of missed distributions can be even more cumbersome for plan participants. The IRS imposes a 50% penalty on missed distributions, meaning the stakes are even higher when beneficiaries are taking out larger sums of money at the end of a 10-year threshold.
“That’s no small amount of money when you’re talking about someone’s retirement savings,” he said. “It could be an extremely expensive mistake.”