Advisors have two years to make big tax-saving moves for their clients, says Ed Slott. After that, a legislative window could close that opportunity forever.

“We all know that we’re going into 2024 and 2025 with low rates, but after that the rates under today’s law are scheduled to go back up to what they were before the Tax Cuts and Jobs Act,” said Slott, founder of tax consultancy Ed Slott & Co.

The Tax Cuts and Jobs Act of 2017 lowered the income tax rates for many earners across the wealth spectrum, but, more importantly, also included a very generous gift and estate tax exclusion that, in 2023, has risen to nearly $13 million. However, many of those provisions are scheduled to sunset at the end of 2025 unless they are extended by Congress.

“You can help out by doing some of the things I talk about,” said Slott. “For example, looking at year-end gifting. That almost $13 million exemption for estate planning goes up to over $13 million this year. … You have two years to get IRA income out at these lower rates. You can be a real hero to your clients by getting better educated on these issues.”

Required Minimum Distribution Confusion
“The number one question we get from every financial advisor is, ‘Who has to take an RMD before year’s end,” said Slott. “It’s very complicated.”

For IRA owners, required distributions depend on their year of birth, he said. This year, 2023, is a transition year. In 2017, the SECURE Act raised the age at which RMDs start. Previous law has them beginning in the year the client turns 70.5. The first SECURE Act raised that to age 72, and last year’s SECURE Act 2.0 raised the starting age again, this time from 72 to 73.

If a client turned 72 last year, in 2022, they had to start taking RMDs and would be required to take their second distribution this year. However, if the client turned 72 this year, in 2023, then they fall under SECURE Act 2.0’s umbrella and would not have to start taking distributions until 2024, the year in which they turn 73.

“Anyone born 1950 or earlier will have to take an RMD this year,” said Slott. “Anyone born in 1951 or later will not—they get to use age 73 as their beginning year.”

Tougher For Beneficiaries
However, required distributions are now more complicated for heirs inheriting assets from traditional IRAs. While under previous law they could “stretch” their IRA distributions over the rest of their lives, resulting in a lower annual income tax bite and more opportunity to grow the assets, the SECURE Act imposed a new 10-year rule on inherited IRA distributions, stating that most heirs would have to empty the IRA by the end of the 10th calendar year after the account holder died.

Initially, Slott and other tax experts assumed that, under the new rule, inherited traditional IRAs would be exempt from required minimum distributions until the 10th year after they changed hands, but subsequent IRS rulings have made clear that many heirs are required to take distributions before that 10-year mark is reached.

Slott says that, to determine whether distributions need to be taken, an account owner or advisor needs to ask three questions: “Two ‘whens’ and one ‘who.’”

First, when did the original IRA owner die? (Or when did the beneficiary inherit the account?) If it was in 2019 or earlier, the beneficiary still qualifies for the stretch IRA rule, and though they’re subject to required distributions, they can usually take much smaller annual withdrawals from the account than those subject to the new regime because their distribution is calculated using their projected life span.

However, if the original account owner died in 2020 or later, the IRA beneficiary is subject to the 10-year rule of the SECURE Act and a second question must be asked: Did the original account owner reach the age at which they would have had to start taking RMDs? If they reached their RMD start date before dying, their heirs will have to continue taking annual RMDs in each year until year 10, when they will be required to exhaust the account entirely.

“That’s because of what the IRS calls the ‘at least as rapidly rule,’” said Slott. “Once the faucet is turned on, it can never be turned off, and once the IRA owner had already begun taking RMDs, the beneficiary must continue, even though they have the 10-year rule.” However, the beneficiary’s RMD calculations are based on their own age, using the same calculation rules from the now antiquated stretch IRA. Which means they take a smaller distribution every year, until they suddenly have to take it all by the end of the 10th year.

It also matters who the beneficiary is—how they are related to the original account older, how old they are, and whether or not they are disabled or chronically ill. Eligible designated beneficiaries, who include surviving spouses, minor children until they reach the age of 21, disabled and chronically ill individuals, and beneficiaries whose age was within 10 years of the age of the original account owner, still qualify for the original lifetime stretch inherited IRA and are not subject to the SECURE Act's 10-year rule.

The rules are so confusing, said Slott, that the IRS has waived penalties for those who fail to take RMDs from inherited traditional IRAs for 2020, 2021, 2022 and 2023. But those who inherited a traditional IRA before 2019, as well as those who qualify as “eligible designated beneficiaries,” are still required to take RMDs, as they still operate under the stretch IRA rule as before.

If the original account owner reaches the year in which they are required to start taking RMDs, but dies before taking their first distribution, their beneficiaries will still have to take RMDs, said Slott, and will have until their income tax filing date in the following year—April 15, 2024, for most people—to take the distribution.

Penalty Change
Slott also noted a change in the Internal Revenue Service’s enforcement of RMDs. In the past, there was a 50% penalty for those who failed to take the distribution in the year it was required—that is, if a client missed a required distribution, they would have to not only take it, but also pay a penalty equal to 50% of it. Now, that penalty has been lowered to 10% to 25% of the required distribution.

“I’m not sure I ever saw anyone pay it,” Slott said. “The IRS agreed it was so harsh that they were asking people to give them any excuse to waive it. They were very generous. I’m hoping they will still be as generous now that the penalty could be as low as 10%.”

On Gifting
With the year rapidly drawing to a close, Slott reminded advisors that this is a great time for gifting, identifying three types of tax-exempt gifting.

One is the annual gift and estate tax exclusion, which allows individuals to give up to $17,000 apiece each year to an unlimited number of people.

The second is an exclusion for those who gift to somebody paying tuition and healthcare expenses, but only if they are paid directly to the provider, said Slott.

“I find grandparents love making these gifts,” he said. “They immediately see it going for the intended benefit, and they can give unlimited amounts for an unlimited amount of people and it doesn’t count against their big exemption.”

The third type is the nearly $13 million lifetime gift-and-estate tax exemption, which a client can use during their life, rather than waiting until after they die, said Slott. When the Tax Cuts and Jobs Act provisions sunset at the end of 2025, the exemption will roll back to approximately half of what it is now.

Clients may also want to give to charity ahead of or during the holidays, said Slott.

“The best assets to give to charity are [traditional] IRAs, because they are loaded with taxes,” said Slott. “We talk about charitable planning for those people who have charitable intent and want to give away money anyway. Don't give money to charity for tax reasons alone. For the majority of your clients who give anyway, if they can do it in a slightly different way, like doing it with an IRA, you can help eliminate some of their tax bill, too, because the charity doesn’t have to pay tax.”