Proposed new regulations from the Internal Revenue Service for inherited retirement accounts would require many heirs to make minimum annual withdrawals from the accounts—leaving less room for the savings to grow tax-deferred over the years.

Many holders of some inherited retirement accounts are in for the hassle of required minimum distributions, under a proposed rule. ILLUSTRATION- ROB DOBI.jpeg

Many holders of some inherited retirement accounts are in for the hassle of required minimum distributions, under a proposed rule. ILLUSTRATION: ROB DOBI

The new rules would provide guidance to the Secure Act of 2019, which made several changes to laws governing retirement accounts.

For traditional individual retirement accounts, the proposed rules—which would apply to accounts inherited after 2019—would affect heirs known as designated beneficiaries. That category includes most beneficiaries other than spouses, such as children over 21 years old and grandchildren.

The new rules wouldn’t apply to beneficiaries of Roth IRAs. But they would affect those who inherit workplace retirement plans such as 401(k)s, 403(b)s and eligible 457(b)s.

Under the proposed rules, if the original account owner died on or after April 1 of the year of his or her 72nd birthday, the affected beneficiaries must take taxable annual withdrawals that empty the account over 10 years, or be subject to a penalty of 50% of the missed required minimum distribution, or RMD, for any given year. Beneficiaries of an heir subject to the new rules would be subject to the same 10-year window as the original beneficiary.

Until now, most financial advisers believed that the affected beneficiaries of the owner of an account who died after 2019 were required to empty the account only by the end of the 10th year after the death (not the 10-year anniversary of the date of death). Though the IRS hadn’t given any specific indication to that effect, advisers generally assumed that no annual withdrawals were required.

“We were surprised, because the IRS had given some conflicting signals in the past, “ says Sarah Brenner, director of retirement education at Ed Slott & Co., a tax consulting firm in Rockville Centre, N.Y. “Now there would be an increased level of complexity and the hassle of having to calculate annual RMDs using tricky rules.”

For those beneficiaries who inherited an account in 2020 and would be subject to the new rules, there is no clear guidance from the IRS yet on how to handle the missed RMD for 2021.  Some experts say to hold off on missed 2021 payouts until the IRS issues a clarification on retroactivity. (By the way, the IRS will often forgive that stiff 50% penalty on a missed RMD if you or your tax adviser explains why.)

The IRS also proposes to establish a uniform age of majority at 21 for inherited retirement accounts, regardless of state laws that may have a lower or higher age or vary depending on whether the child is still in school. Children who inherit an account wouldn’t become subject to the new rules until they reach age 21.

The open comment period for the proposed regulations ends at the end of May. A public hearing will follow on June 15, after which final rule-making will occur.

Mr. Sloane is a writer in New York. He can be reached at .

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Robert A Anderson III, CLTC®, LUTCF®, ChFC®
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