Do you have a tax-favored retirement account, such as a traditional IRA? If so, that account will be subject to the federal income tax required minimum distribution (RMD) rules once you reach a certain age. (This applies even if you acquired the tax-favored retirement via an inheritance.)
These rules mean you’ll have to:
A) Make annual withdrawals from the account(s) and pay any resulting income tax
B) Lower the balance of your inherited Roth IRA sooner than you may have planned
But even if this information isn’t news to you, recent tax law changes could impact the way you approach these accounts. Let’s take a deeper look at the most recent rules.
What to know about Required Minimum Distribution (RMD)
Under RMD rules, affected individuals need to take annual withdrawals (required minimum distributions) from tax-favored accounts. Unless the RMD meets the definition of a tax-free Roth IRA distribution, doing this will typically trigger a federal income tax bill. A state tax bill is also possible.
There is a favorable exception for original owners of Roth IRA accounts, who are exempt from RMD rules during their lifetimes. However, RMD rules do come into play for inherited IRAs, including Roth IRAs.
Starting age delayed
Enacted in 2022, the SECURE 2.0 law adjusted the age at which account owners must start taking RMDs. Instead of taking RMDs for the calendar year in which you turn age 72, you may now decide to wait to take your initial RMD until April 1 of the year after you turn 72.
SECURE 2.0 also increased the starting age for RMDs to 73 for account owners who turn 72 between 2023 and 2032. So, if you turned 72 in 2023, you’ll be 73 in 2024, and your initial RMD will be for calendar 2024. You must take that initial RMD by April 1, 2025. Otherwise, you could face a penalty for failure to follow the RMD rules.
The tax-smart strategy is to take your initial RMD, which will be for calendar year 2024, before the end of 2024 instead of in 2025 (by the April 1, 2025, absolute deadline). Then, take your second RMD, which will be for calendar year 2025, by Dec. 31, 2025. With this approach, you avoid having to take two RMDs in 2025 and paying double the taxes in that year.
Penalty reduced
The IRS can assess an expensive penalty if you fail to withdraw at least the RMD amount for the year. Prior to the enactment of SECURE 2.0, this penalty was 50% on the shortfall. That penalty is now 25%, or 10% if you withdraw the shortfall within the designated “correction window.”
10-year liquidation rule draws controversy
Under the original SECURE Act, most non-spouse IRA and retirement plan account beneficiaries are required to empty inherited accounts within ten years of the account owner’s death. Otherwise, they may face a penalty tax for failing to comply with the RMD rules.
According to IRS proposed regulations issued in 2022, beneficiaries who are subject to the original SECURE Act’s 10-year account liquidation rule must take annual RMDs, calculated in the usual fashion — with the resulting income tax. The inherited account must still be empty at the end of the 10-year period. This means beneficiaries can’t just wait ten years and then empty the inherited account.
This requirement to take annual RMDs during the ten-year period has drawn much debate. And, as a result, the IRS stated in Notice 2023-54 that beneficiaries subject to the ten- year rule who did NOT take RMDs in 2023 will not be penalized. The Notice also explains that the IRS will issue new final RMD regulations, which won’t take effect until sometime in 2024 (at the earliest).
Questions? Smolin can help
Required Minimum Distribution rules can be confusing, especially for beneficiaries. However, breaking these rules can be costly. Contact your accountant for the most up-to-date advice on the best tax-wise RMD strategy for your unique situation.