Don’t be surprised if your clients are walking into your office in a state of bewilderment over something they’ve read recently about the IRS’s distribution rules for inherited IRAs.
Until the law changed a few years ago, a client who was named as the beneficiary of a parent’s IRA, for example, could count on a relatively straightforward and tax-smart method of withdrawals called the “stretch IRA.” With the passage of the SECURE Act, that changed for many clients who inherited an IRA after December 31, 2019. Instead of taking distributions over their lifetimes, affected clients would need to withdraw the entire inherited IRA account within a 10-year period as calculated under the law.
Too bad about the loss of the stretch IRA, but we’ve all had time to adjust to the new IRS rules, right?
Unfortunately, no. The IRS rules are, at the moment, clear as mud. Concern escalated when the IRS issued proposed (but not yet final) regulations earlier this year. Advisors and clients are facing an acute discrepancy between what had been understood by practitioners immediately after the SECURE Act was passed, on one hand, and what the IRS has included in the proposed regulations, on the other.
Specifically, some non-spouse beneficiaries of an inherited IRA may not be able to wait until the 10-year post-inheritance mark to fully withdraw the funds in a lump sum, but instead, according to the proposed regulations, must begin taking annual distributions immediately following the inheritance and throughout the statutory 10-year period during which all funds must be withdrawn. This is a hard pill to swallow for clients who were counting on years of additional tax-free growth and who had hoped to defer an income tax hit until a lower-income year.
The situation is complicated but worth understanding because of the potential headaches the proposed regulation could cause for your clients who are caught in the gray area (this very clear article is helpful).
On the bright side, the current state of confusion could present an opportunity to serve your philanthropic clients, as inherited IRAs can also make QCDs. Some might prefer the joy of making disbursements to charity over the rigors of still-fuzzy regulation.