How an IRS Change Could Hurt Your Heirs

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Woman with empty wallet
B-D-S Piotr Marcinski /

The IRS is weighing a change that could leave your heirs poorer than you might hope.

The new federal regulations would require many people who inherit money through traditional individual retirement accounts (IRAs) as well as 401(k)s, 403(b)s and eligible 457(b)s to withdraw funds from the accounts every year over a 10-year period, The Wall Street Journal reports.

The change would apply to most beneficiaries other than spouses, and would stretch back to those who have inherited money after 2019. Children age 21 and older, grandchildren and most others who receive money from an affected account would need to follow the new regulations, or rules.

The WSJ reports that the proposed change would require beneficiaries to take minimum taxable withdrawals every year for 10 years from their inheritance in situations where the original account owner died on or after April 1 of the year of his or her 72nd birthday.

These withdrawals, technically known as required minimum distributions (RMDs), must empty the account within the 10-year period.

Heirs would pay a penalty of 50% on any RMD amounts that they failed to withdraw according to the schedule defined by the new IRS rules.

How the regulations could hurt heirs’ wealth

The proposed change has the potential to leave your heirs less wealthy. That is because the money you bequeath to heirs would have less time to grow in tax-advantaged accounts before they would be forced to withdraw it.

Over time, that can make a substantial difference in how much money they accumulate from the initial amount that you leave them.

The proposed rules are intended to clarify changes resulting from the federal Secure Act of 2019. However, as the details emerge, they come as a surprise to some financial advisers. As the WSJ reports:

“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.”

What happens next

There is an open comment period regarding the proposed rule changes that expires before the end of the month, to be followed by a public hearing in June. A final decision will come after that.

If you wish to submit a comment about the proposal, visit the webpage for it and click on the blue “Comment” button. Just note that after you submit a comment, you can’t edit or withdraw it, and it will be posted publicly.

Another advantage of Roth IRAs?

If the IRS goes ahead with the changes, the new rules will add to the growing number of reasons why it makes sense for some people to consider putting money into a Roth IRA instead of a traditional IRA.

With a Roth IRA, the account owner pays taxes upfront, and heirs will not owe any taxes on the money they inherit. Thus, the new rules would not apply to Roth IRAs.

Wondering which approach makes sense for you? Trying to simply guess can lead to a costly error. Consider stopping by Money Talks News’ Solutions Center and search for a great financial adviser.

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