Inherited IRAs: Big headache or big opportunity?
Don’t be surprised if your clients are walking into your office in bewilderment over something they’ve read recently about the IRS’s distribution rules for inherited IRAs.
What’s the back story?
Until the law changed a few years ago, a client named as the beneficiary of a parent’s IRA, for example, could count on a relatively straightforward and tax-savvy 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 ten years as calculated under the law.
What’s the problem now?
Too bad about the loss of the stretch IRA, but we’ve all had time to adjust to the new IRS rules, right? Wrong. Unfortunately, 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 the one hand, and what the IRS has included in the proposed regulations, on the other hand.
Specifically, some non-spouse beneficiaries of an inherited IRA may not be able to wait until the 10-year post-inheritance mark to withdraw the funds in a lump sum entirely 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immediately following the inheritance and throughout the statutory 10-year period during which all funds must be withdrawn.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 had hoped to defer an income tax hit until a lower-income year.
The situation is complicated but worth understanding (we like this very clear article) because of the potential headaches the proposed regulation could cause your clients who are caught in the gray area.
A charitable giving opportunity?
The current state of confusion could present a golden opportunity to serve your philanthropic clients.
First, anytime you talk about IRAs, inherited or not, you’ll want to ensure your client knows about Qualified Charitable Distributions (QCDs). As tax enthusiasts, we may always feel we talk about QCDs. Hearing the message multiple times is crucial for clients–who are likely not tax experts–to fully appreciate the QCD’s benefits.
As a reminder, through QCDs, a client who is 70½ or older can use a traditional IRA to distribute up to $100,000 ($200,000 for a couple) per year, which happily counts toward satisfying Required Minimum Distributions, to a qualified charity, including certain types of funds at the Foundation. The client does not report the distribution as taxable income because it goes straight to charity.
Second, a QCD could come in handy for your clients owning inherited IRAs who are caught in the confusion of SECURE Act proposed regulations. The IRS does permit taxpayers to make QCDs from inherited IRAs, not just their IRAs. This option could be a welcome relief to clients facing the more stringent proposed IRS regulations governing the payout requirements for inherited IRAs.
Please contact us if you have questions about how your clients can use their IRAs to support their favorite charitable causes. We’d be glad to help.