The tax rules applied to retirement accounts in the U.S. are always changing, providing opportunities for advisors to find and offer new strategies to their clients, according to IRA specialist Ed Slott.
While no major tax bills have been passed so far this year by Congress, the IRS is still in the process of digesting and issuing rules based on the last two pieces of retirement tax legislation signed into law, the 2019 SECURE Act and last year’s SECURE 2.0 Act, Slott said yesterday on a Financial Advisor webcast,
“We’re coming into the fourth quarter, believe it or not, and we’re doing this on the day that football starts,” said Slott. “You all know what happens in the fourth quarter: It all hits.”
The IRS has recently handed down at least six key rulings clarifying what IRA owners, tax professionals and advisors need to do in light of recent laws and product innovations, said Slott.
RMDs From Inherited IRAs
After it was passed at the end of 2017, the original SECURE Act for the most part did away with the stretch-IRA rule for inherited traditional IRAs. Under this rule, required minimum distributions (RMDs) from inherited traditional IRAs could be calculated based on the IRA beneficiary’s life expectancy, significantly lowering the amount required to be distributed annually from the account.
The SECURE Act instead applied a 10-year rule for most IRA beneficiaries for accounts inherited when the original owner had died on or before Jan. 1, 2020. Under this rule, the new IRA owner has 10 years to empty the assets from the inherited account unless they fall within five special categories of eligible designated beneficiaries.
“People like me thought that wasn’t so bad, because it seemed like there were no RMDs, so you didn’t have to worry. You could just take everything out at the end of the 10th year,” said Slott. “In early 2022, the IRA released proposed regulations—and they're still talking about it—they said ‘not so fast' on the 10-years rule.”
The proposed regulations would require annual required distributions to be taken from inherited traditional IRAs if the original account owner was already required to take minimum distributions at the time of their death, said Slott.
However, the proposal created so much confusion about who was supposed to take the distributions and how the distributions would be calculated that the IRS issued relief for RMDs required to be taken from inherited IRAs in 2021, 2022 and now 2023, said Slott.
“The IRS has said they won’t penalize you for not taking it, which in essence means they don’t have to be taken,” said Slott. “This is now the rule in 2023 for those who inherited in 2020 or later from an account owner who died on or after beginning RMDs.”
Speaking of RMDs, 2023 is an important year because the SECURE 2.0 Act extends the required beginning date for RMDs from the year the traditional IRA owner turns 72 to the year they turn 73, said Slott. However, the law extending the required beginning date was passed in December of 2022, which meant that a lot of IRA owners had already received notification from their advisors and brokers that they had to take an RMD in 2023. Due to the confusion, the IRS has also provided relief allowing IRA owners to return their required minimum distribution to their account if they took it under the mistaken assumption that, because they turned age 72 in 2023, they had reached their required beginning date.
SECURE 2.0 Act IRA Annuity Aggregation
Section 204 of the SECURE 2.0 Act changes the way distributions from annuities held in IRAs are calculated relative to an IRA owners required minimum distribution, said Slott.
“Before SECURE 2.0, if you had an annuity within an IRA it was as if you had a separate IRA,” said Slott. “Whatever the payout from the annuity was, it satisfied the RMD from the IRA but it couldn’t be used to satisfy the RMDs from other IRAs. Now it can.”
RMDs are now aggregated among all of an IRA owners qualified accounts, including annuities, said Slott.
So if a client’s total RMD for all their IRA assets is calculated to be $35,000, and they have an annuity within an IRA that pays out $30,000 in income annually, all of that $35,000 can be used against the client’s RMD, said Slott.
The Roth 401(k) Catch-Up Mess
Another major change in SECURE 2.0 attempts to raise more tax revenue by requiring high earners—those who make more than $145,000 in wages from a single employer—to make any annual 401(k) catch-up contributions in a Roth account versus a tax-deferred traditional account.
As the law stands, workers in multiple-employer plans who may have $145,000 or more in annual income but from two or more employers are exempt from the rule—meaning they can make their catch-up contributions in either a tax-deferred or an after-tax Roth account.
“The financial institutions ... said ‘wait a minute, this is effective Jan. 1, 2024. There’s no way we’ll get updated plans and amendments out to 10s of millions of employees by that time,” said Slott. “So the IRS said they’ll provide two years of relief on this provision and it will not be effective until 2024.”
High wage earners probably want to avail themselves of a Roth 401(k) anyway, if they have access to one, said Slott, to avoid what will likely be higher tax rates in the future
Surviving Spouse 327 Election
For the first time in many years, the SECURE 2.0 Act is changing the rules for surviving spouses who inherit IRAs, said Slott.
“Congress has always been kind to the surviving spouse, but for some reason Congress got involved with SECURE 2.0 and put in one or two sentences that caused mass confusion with the surviving spouse rule,” said Slott.
Under the 327 Election rule of SECURE 2.0, a surviving spouse can choose to be treated as if they were the deceased spouse for the purposes of IRA distributions. If a 327 Election is made, the surviving spouse would begin RMDs when the deceased account owner would have reached RMD age.
“Here’s the crazy part about it—the people who benefit from it are the minority of surviving spouses where the younger spouse dies first, which rarely happens,” said Slott.
Now surviving spouses ages 59.5 and older have three options when inheriting an IRA--to roll it over, to remain a beneficiary under their own age and beginning date, or to use their spouse’s required beginning date by making a 327 Election, said Slott. “Normally, when they write a law, they do it to correct a situation. I don’t know what they did here except to make it more complicated for a surviving spouse to inherit," he said.
It is likely that the IRS will delay this rule, which is slated to go into effect in 2024, said Slott.
Charitable Gift Annuities
Starting this year, the SECURE 2.0 Act allows traditional IRA owners to make a one-time $50,000 gift from their IRA to a charitable gift annuity (CGA). A CGA acts as a tax-free life-income gift to a charity. The IRA owner can designate themselves and/or their spouses as income beneficiaries, and the income from the annuity is treated as ordinary income.
The IRS has clarified that the CGA contribution has to all happen within the same calendar year—so if an account owner contributed $30,000 to one or more CGAs in 2023, they could not contribute the remaining $20,000 of their lifetime limit in another calendar year.
Furthermore, like the qualified charitable contribution (QCD), the CGA is only available to account owners age 70.5 or older—while for most IRA owners, the required beginning date for RMDs is 73.
“It’s not an investment, it could end up being a poor investment. It’s for those who want to give to charity and get a tax break out of it,” said Slott. “It’s a pretty good move for clients who normally give to charity. So we have the $50,000 rule clarified, but there are things that we don’t know about, like does it count against the $100,000 limit for QCDs. I think it does.”
NFTs in IRAs
Slott closed his presentation on Thursday with a warning against using non-fungible tokens (NFTs) in iRAs. An NFT is a unique digital token that usually gives the holder rights to something—like access to an event, or artwork and collectibles.
“You can pretty much invest IRA funds into anything but collectibles, life insurance and S-corporation stock,” said Slott. In recent years, some investors have started putting NFTs in their traditional IRAs to enjoy the tokens’ growth in value while deferring or eliminating taxes on their gains.
In March of this year, the IRS issued Notice 2023-27 that clarified how NFTs would be treated within IRAs—specifically, if an NFT within an IRA confers rights to a collectible like a piece of art, the IRS would consider that a prohibited investment. Furthermore, if the account owner uses the art held in the IRA by hanging it in their home, it could be considered a prohibited transaction.
“Even if it isn’t a prohibited transaction, it would be considered a deemed distribution, and by this rule it would be deemed to have been distributed at its original cost,” said Slott. “Now many people in the NFT market got destroyed recently—they bought NFTs of baseball cards or pictures, maybe a client paid $200,000 of their IRA money to NFTs. Now that NFT might be worth zero because of the crash. With this ruling, it’s still taxable at the original cost. It’s worth nothing now, but it will be taxed on that original $200,000. Very dangerous.”