Inherited retirement account owners won’t face penalties for not withdrawing money this year
Share Now on:
Inherited retirement account owners won’t face penalties for not withdrawing money this year
If you’ve inherited a traditional individual retirement account, you can rest easy this year: You won’t face a financial penalty if you fail to withdraw money, according to the Internal Revenue Service.
When it comes to retirement accounts, many holders eventually must take out a minimum amount each year (also known as a required minimum distribution). A number of factors determine whether, and when, this requirement applies to you, like your age, the type of retirement account you have and — if you inherited it — what your relationship was to the original owner.
Minimum withdrawal rules apply to accounts like traditional IRAs and 401(k)s, which are vehicles for investing pretax dollars. These rules are meant to make sure your account “doesn’t turn into a permanent tax shelter,” Marketplace contributor Chris Farrell explained. If you break them, you could face an excise tax of 25% on the amount you did not withdraw (although it can drop to 10% if you withdraw the amount you were supposed to within two years).
The Secure Act of 2019 required certain people who inherited IRA funds on or after Jan. 1, 2020, to withdraw everything within 10 years. Before this law, they were previously allowed to make these withdrawals over their lifetime. To further complicate matters, the IRS later released regulations calling for beneficiaries to make annual withdrawals throughout those 10 years.
“There was initial confusion because practitioners and taxpayers thought the distribution had to be completed by the end of 10 years and were putting it off to do it at the end of that period,” said William Stromsem, an accountancy professor at the George Washington University School of Business.
Note: If you are an eligible designated beneficiary, such as a spouse, a child or a disabled person, you are not subject to these 10-year rules and you can still “stretch out” minimum distributions or withdrawals. For children, this exemption ends the year you turn 21. In that year, the 10-year withdrawal rule kicks in.
Given the confusion, the IRS has been waiving minimum withdrawal requirements since 2021. Waiting until the end of a 10-year period has advantages. Stromsem pointed out that some IRA funds are invested in illiquid assets, such as art, collectibles, land and small businesses. Enforcement of the minimum withdrawal rule “could have forced a rushed sale to get cash,” Stromsem said.
Keeping your funds invested that long would also allow them to continue appreciating, he explained.
The IRS’ recent notice briefly gives beneficiaries a reprieve from annual withdrawals, which should be welcome relief for taxpayers. “It takes away the uncertainty for another year,” Stromsem said.
But questions linger. There are a couple of scenarios the IRS might explore if you were supposed to begin making withdrawals in 2021.
“One would be that the withdrawals would be taken over the next six years to completely empty the IRA using the six-year period for the calculation instead of the 10-year period,” Stromsem said. “The second scenario would be that the IRS would expect you to have a catch-up [required minimum distribution] in the fifth year to make up for the lack of withdrawals over the first four years, and then the rest would be taken over the last six years, as if the entire amount was distributed over 10 years.”
But you shouldn’t count on either scenario, he added.
“Hopefully the IRS will issue additional guidance. But it seems like this is the last delay, so taxpayers should be prepared to comply next year or face a 25% excise tax on the amount of the distribution shortfall,” Stromsem said.
There’s a lot happening in the world. Through it all, Marketplace is here for you.
You rely on Marketplace to break down the world’s events and tell you how it affects you in a fact-based, approachable way. We rely on your financial support to keep making that possible.
Your donation today powers the independent journalism that you rely on. For just $5/month, you can help sustain Marketplace so we can keep reporting on the things that matter to you.
