2023 RMD Rule Changes: 3 Common Client Questions

Inherited IRAs and RMDs in 2023

Another part of the recently issued IRS guidance on RMDs dealt with the 10-year rule surrounding beneficiaries of inherited IRAs, specifically whether or not they needed to take an RMD in 2023.

The original Secure Act eliminated the ability for many inherited IRA beneficiaries to stretch their inherited IRA distributions. Those who inherited IRAs on or after Jan. 1, 2020, must withdraw funds over a 10-year period. There are some exceptions for certain qualified beneficiaries such as a surviving spouse.

Whether these beneficiaries would need to take RMDs over this 10-year period has been a major source of confusion. At first, the thought was no. However, the IRS then announced in proposed regulations that if the original account holder had died after their required beginning date to commence their own RMDs, then the beneficiaries would need to take RMDs on their inherited IRA in years one through nine.

The IRS has since indicated that there will be no penalties for RMDs not taken in 2021 or 2022 due to lack of guidance or other reasons. Their most recent announcement indicated that there will be no RMD requirement for 2023, either.

The requirement to fully distribute the inherited IRA account over the 10-year time period is still in place, however. We don’t know exactly if or when the RMD requirement will be implemented and enforced.

This means that you need to work with your client to decide on a schedule for taking their distributions from their inherited IRA over the 10-year period, especially if the inherited IRA is a traditional IRA or a Roth in which the original account owner did not meet the five-year rule prior to their death.

This planning should take into account your client’s tax situation. Waiting until year 10 to take the full distribution could result in a significant tax bill if the account balance is large, and/or if your client finds themselves in a high tax bracket. It may make sense to take distributions in any years in which your client’s income is lower than normal, or at least to spread them out over the 10-year period to avoid a significant tax hit in year 10.

Other Secure 2.0 Act RMD Changes

The Secure 2.0 Act included some other RMD rule changes that you and your clients need to be aware of.

Reduced Penalties for Missed RMDs

The Secure 2.0 Act reduced the penalty for a missed RMD from 50% of the amount not taken to 25% of that amount beginning in 2023. If the error is corrected quickly in the eyes of the IRS, the penalty may be reduced to 10%.

In some cases, if your client can demonstrate that the missed RMD was due to a situation beyond their control, such as an illness, they may be able to have the penalty waived. The exact circumstances where this forgiveness might be granted have not been clearly defined.

As IRA expert Ed Slott explained to ThinkAdvisor in May:

For most people, correction must be made by the end of the second tax year following the year for which the RMD was missed. The RMD would need to be taken and the 10% penalty paid during this window.

But the penalty can also be waived altogether by filing IRS Form 5329. The missed RMD must still be made up and you must provide a reason for the missed RMD, like medical issues, death in the family, confusion on the rules or incorrect advice.

No Roth 401(k) RMDs Starting in 2024

Beginning in 2024, there will be no RMDs for designated Roth accounts in a 401(k) plan. This will put these accounts on par with Roth IRAs when it comes to RMDs. While these withdrawals were not taxable if certain requirements were met, those with money in a Roth 401(k) were still forced to take a withdrawal or to roll these accounts over to a Roth IRA in order to preserve the tax-free nature of these funds.

Summary

For many of your clients, 2023 is a year of potential confusion over the status of RMDs from various accounts. These clients need your help to stay on track for this year and to plan for the years ahead.