What are Required Minimum Distribution Rules for 2023?

After a certain age, retirement account owners are required to take required minimum distributions from traditional IRAs and 401(k)s. The SECURE 2.0 Act has changed the rules, reports the article “New RMD Rules for 2023” from U.S. News & World Report.

Before the SECURE 2.0 Act, the age to start RMDs was 72 for retirement accounts, including both traditional IRAs and 401(k)s. Now, the RMD age has increased in two steps. Starting in 2023, the RMD age increases to 73, and in 2033, the RMD age will increase to 75. If you were born between 1951 and 1959, you’ll need to start RMDs after age 73. Born after 1960? You can delay RMDs until after age 75.

There are important deadlines, and while you get extra time to take your first RMD, you must take subsequent RMDs every calendar year.

Here’s the twist: remember, RMDs are taxable. If you take your first RMD in 2023 because you celebrate your 72nd birthday that year, you’ll have some decisions to make. You can take the RMD by December 31, 2024, or delay it to no later than April 1, 2025. But if you delay it to April 2025, you’ll take two RMDs in one tax year.

If your income from Social Security and other sources is more than you need, those higher ages for RMDs have their advantages. Retirement savings accounts may grow tax-free for a longer period of time. The change may also bring savings in Medicare costs. The price of Medicare premiums is tied to income. When retirees take distributions from pre-tax retirement accounts, it increases their income and their premiums. By waiting on withdrawals, income can be lowered, leading to lower Medicare premiums at that time.

However, the delay in taking distributions may also lead to higher taxes during later stages of retirement. If you don’t take funds early, you may find yourself with higher RMDs later, leading to larger tax bills.

Account owners who don’t take a Required Minimum Distribution at the right time usually face harsh penalties. Prior to the SECURE 2.0 Act, the tax penalty was 50% on their required amount not withdrawn. Now the penalty is 25%. If the mistake is corrected quickly, the penalty can even decline to 10%, as long as the person can demonstrate the missed RMD was due to an error and reasonable steps are being taken to resolve the issue.

There are changes to qualified charitable distributions as well. Account owners age 70 ½ and older may now make IRA qualified charitable distributions of up to $100,000 per year without owing income tax on the transaction, which can count as their RMD for the year. The qualified charitable distribution limit is now linked to inflation and may increase in future years. A one-time gift of $50,000 may be made directly to an eligible entity through a charitable gift annuity, charitable remainder unitrust or charitable remainder annuity trust.

Based on the SECURE Act 2.0, Roth 401(k) account owners no longer have to take RMDs at all. This aligns the Roth 401(k) with Roth IRAs, which also do not require any distributions in retirement.

Reference: U.S. News & World Report (Feb. 10, 2023) “New RMD Rules for 2023”

 

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What Should I Know About Annuity Beneficiaries?

Annuities are contracts between you and an insurance company, which is unlike retirement investment accounts like 401(k)s or individual retirement accounts (IRAs).

Forbes’ recent article entitled “What Is An Annuity Beneficiary?” explains that, with an annuity, you make a lump sum payment or a series of payments over a set period to the insurance company. In exchange, the insurance company will pay out a stream of income in retirement or at a predetermined future date, depending on the type of annuity purchased.

There are a number of benefits to annuities, such as a predictable income in retirement, tax-deferred growth and a death benefit if you pass away. There are several different types of annuities, but they can be grouped into three main categories:

  • Fixed annuity. If you buy a fixed annuity, the insurance company will pay you a minimum rate of interest and a fixed amount of periodic payments. These are the safest type of annuity because you know the minimum you’ll earn.
  • Indexed annuity. This combines features of annuities and investment securities. The insurance company’s payments are based on the performance of a stock market index, such as the S&P 500. When the index performs well, the value of the indexed annuity increases. However, it can also decline along with the index’s performance.
  • Variable annuity. With this type of annuity, you can use your annuity payments for investment products, like mutual funds. Your payout is based on the performance of how much you invest and the rate of return on those securities. These annuities can be risky. However, they have the potential for higher returns.

Whoever signs an annuity contract is considered the owner, who selects the way the annuity will be funded, how payouts will be made and the recipient of the payouts. They also name beneficiaries, control withdrawals and have the power to cancel the contract. An “annuitant” is the person who gets income payments from an annuity contract.

Some annuities have death-benefit provisions, so you can name someone to inherit the remaining annuity payments if you die before it’s been fully paid. The designated recipient of that benefit is known as the annuity beneficiary.

The death benefit of an annuity is typically the remaining contract value or the amount of premiums, minus any withdrawals, upon the annuity holder’s death.

Reference: Forbes (Jan. 19, 2023) “What Is An Annuity Beneficiary?”

 

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When Is Life Insurance Taxable to Beneficiaries?

When people purchase life insurance policies, they designate a beneficiary who will benefit from the policy’s proceeds. When the life insurance policyholder dies, the policy’s beneficiary then receives a payout known as the death benefit.

Yahoo Finance’s recent article entitled “Will My Beneficiaries Pay Taxes on Life Insurance?” says the big advantage of buying a life insurance policy is that, upon death, your beneficiaries can get a substantial lump sum payment without taxation, unless the amount of the life insurance pushes your estate above the applicable federal estate tax exemption. In that case, your estate will need to pay the tax.

While death benefits are usually tax-free, there are a few situations where the beneficiary of a policy may have to pay taxes on the lump sum payout. When you earn income from interest, it’s typically taxable. Therefore, if the beneficiary decides to delay the payout instead of receiving it right away, the death benefit may continue to accumulate interest. The death benefit won’t be taxed. However, the beneficiary will typically pay taxes on the additional interest.

If a policyholder decides to name their estate as the death benefit beneficiary, the estate could be subject to taxation. When you don’t designate a person as your beneficiary, the proceeds from the life insurance policy are subject to Section 2024 of the IRS code. That says if the gross estate incorporates proceeds of a life insurance policy, the value of the policy must be payable to the estate directly or indirectly or to named beneficiaries (if you had any “incidents of ownership” throughout the policy term).

The proceeds of a life insurance policy may also pass to the estate if the beneficiary dies, and there are no contingent beneficiaries. If you have a will in place, the proceeds will be paid out according to the terms of the will. If there’s no will in place, the probate court decides the way in which to distribute your assets.

The individual insured on a life insurance policy and the policyholder are usually the same person. The policyholder then names a beneficiary. However, a gift tax may apply if the insured, the policyholder and the beneficiary are three different parties. Because the IRS assumes the death benefit was a gift from the policyholder to the beneficiary, you might have to pay gift taxes on the death benefit.

Beneficiaries usually won’t have to pay taxes on life insurance proceeds. However, some situations can result in a taxable event. Be sure that your beneficiary designations are clearly outlined in the policy to avoid taxation.

Reference: Yahoo Finance (Jan. 17, 2023) “Will My Beneficiaries Pay Taxes on Life Insurance?”

 

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What’s an Annuity ?

An annuity is a contract between an investor and a life insurance company. The purchaser of an annuity pays a lump-sum or several installments to the insurer, which then provides a guaranteed income for a certain period—or until their death.

Forbes’ recent article entitled “What Is A Joint And Survivor Annuity?” says that understanding an “annuitant” is key to understanding how a joint and survivor annuity works. An annuitant may be either the buyer or owner of an annuity or someone who’s been selected to get the payouts. A joint and survivor contract typically benefits joint annuitants: a primary annuitant and a secondary annuitant. Under this policy, both get income payments during the lifetimes of both the owner and their survivor.

With joint life contract, you can expect payments throughout the lifetime of the primary annuitant. If that person passes away, the survivor—the other annuitant—receives payouts that are the same as or less than what the original annuitant received. However, if the secondary annuitant dies ahead of the primary annuitant, survivor benefits aren’t paid when the primary annuity dies. The contract buyer can designate themself and another person, like their spouse, as joint annuitants.

A joint and survivor annuity differs from a single life annuity in a few ways:

  • A single-life benefits only the owner, so income payouts cease when that person dies; and
  • A single-life usually pays out less than a joint and survivor annuity, since a single-life contract covers just one life, while a joint and survivor covers two.

Under some joint and survivor annuities, the amount of the payout is decreased after the death of the primary annuitant. The terms of any decrease are set out in the contract.

The payout to a surviving secondary annuitant, generally a spouse or domestic partner, ranges from 50% to 100% of the amount paid during the primary annuitant’s life, if the contract was bought through certain tax-qualified retirement plans.

Ask these three questions before setting up a joint and survivor annuity:

  • How much in payout is needed for both annuitants to support themselves?
  • Do you have other assets (like a life insurance policy) to help the surviving joint annuitant after one of the annuitants dies?
  • How much would the payouts be lessened after the death of a joint annuitant?

Remember that you usually can’t change the survivor named in a joint and survivor annuity.

Reference: Forbes (Dec. 19, 2022) “What Is A Joint And Survivor Annuity?”

 

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401(k) Does Potential IRS Change Have an Impact on Estate Plan?

The new federal regulation would require many people who inherit money through traditional 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, according to The Wall Street Journal.

Money Talks News’ recent article entitled “How an IRS Change Could Hurt Your Heirs” says that the change would apply to most beneficiaries other than spouses, and would apply to those who inherited money after 2019.

Children 21 and older, grandchildren and most others who get money from an affected account would need to follow the new regulations or rules.

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 deplete the account within the 10-year period.

Heirs would pay a penalty of 50% on any RMD amounts they didn’t withdraw according to the schedule defined by the new IRS rules.

The proposed change has the potential to leave your heirs less wealthy. The reason 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, this can make a big difference in how much money they accumulate from the initial amount you leave them in your 401(k) .

The proposed rules are designed to clarify changes resulting from the federal Secure Act of 2019.

If the IRS moves forward 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 As a result, heirs won’t owe any taxes on the money they inherit. Therefore, the new rules wouldn’t apply to Roth IRAs.

Reference: Money Talks News (May 13, 2022) “How an IRS Change Could Hurt Your Heirs”

 

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RMD Formula Changes for First Time in 20 Years

For the first time in two decades, the IRS has updated actuarial tables used to determine Required Minimum Distributions, the amount taxpayers are required from their retirement accounts starting at age 72, reports Yahoo! Money in the article “Good News for Retirees: RMD Formula Changes for First Time in Decades.”

The new tables rely on longer lifespans to calculate RMDs from tax deferred accounts, including traditional IRAs, 401(k)s and other similar retirement accounts every year.

One of the key benefits of retirement accounts are the tax advantages they offer. Traditional IRAs and 401(k)s allow savers to defer taxes until funds are withdrawn, letting their investments grow over an extended period of time. However, as with all good things, there are limits. To encourage people to take funds from the accounts (which generate tax revenues), the IRS requires a certain amount of money be taken out after a certain age.

The age requirements have changed over the years. Before the SECURE Act of 2019, withdrawals were required starting at age 70.5. After the SECURE Act, if you reached age 70.5 in 2019, the prior rules applied, and you had to take the first RMD by April 1, 2020. However, if you reached 70.5 in 2020 or later, the first RMD needs to be taken by April 1 in the year after you reach age 72.

Here are the accounts subject to RMDs:

  • Traditional IRAs
  • SEP IRAs
  • SIMPLE IRAs
  • 401(k), retirement plan from private sector employers
  • 403(b), retirement plan for public employees and nonprofits
  • 457(b), retirement plan for some state and local government employees

Profit sharing plans and other defined contribution plans are also included in this category. Roth IRAs are not subject to RMDs.

With the IRS raising the average life expectancy from 82.4 to 84.6, retirees will also need to make their retirement savings account last longer. Therefore, the RMDs starting in 2022 will be less than those from the prior calculation, which has been the same since 2002. Smaller RMDs will also lower tax liabilities and might even put some people into a lower tax bracket.

You can still withdraw as much as you like from an IRA or the accounts listed above. However, be mindful of the resulting tax bill.

Reference: Yahoo! Money (June 15, 2022) “Good News for Retirees: RMD Formula Changes for First Time in Decades”

 

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What Is the Proposed IRS Anti-Clawback Provision?

IRS Anti-Clawback Provision – The proposed amendment is designed to fix some loopholes in a 2019 regulation passed in response to the 2017 Tax Cuts and Jobs Act. The 2017 law doubled the value of the estate and gift tax exemption until December 31, 2025, when it goes from $12.06 million to $5.49 million. According to this recent article from Financial Advisor titled “Amending The IRS’s Anti-Clawback Provision on Gifting,” the law generated concern among those who wanted to make large gifts to take advantage of the historically high federal estate and gift tax exemption.

The concern was whether the IRS would attempt to clawback the taxes, if the taxpayer died after 2025. This is when the estate tax reverts back to a much lower number. A regulation was issued in 2019 to reassure taxpayers and explain how they could take advantage of the high exemption as long as they made gifts before 2026, regardless of the exemption at the time of their death.

The IRS recognized this as a good step. However, it had a loophole and hence the new proposed amendment. The amendment provides clarity on what constitutes an actual gift. If the donor garners a benefit from the gift or maintains control over the gift, is it really a gift?

Giving the gift of a promissory note worth $12.06 million to lock in the high exemption and leaving it unpaid until death, for instance, is not a gift. The person is not actually giving anything away until after death. Therefore, the note is part of the taxable estate and bound by the estate tax exemption amount in place at the day of death.

The same goes for a person who gives ownership interests in a limited liability company, while continuing to serve as the company’s manager. Taxpayers must be very careful not to mischaracterize their gifts to stay on the right side of this regulation.

Another example: let’s say a person puts a $12 million vacation home into an LLC, with clear directions for home to be kept in the family, and then makes gifts of the LLC ownership interests to the children. If the donor wants those gifts to max out the current $12.06 million exemption, rather than be subject to the lower exemption in place at the date of death, the owner should not be the manager of the LLC. The same goes for the owner living rent-free in any property he’s gifted to anyone, if the wish is to take advantage of the gifting exemption.

In the same way, a mother who places money into a trust fund for a child may not serve as a trustee and control the assets and distributions, if she wishes to take advantage of the tax benefit.

If your estate plan uses grantor annuity trusts (GRATs), Grantor Retained Income Trusts (GRITs) and qualified personal residence trusts (QPRTs), speak with your estate planning attorney. If you die during the annuity period or term of the trust, your estate may lose the benefit of the anti-clawback regulation.

If the amendment is approved, which is expected in late summer, make sure your estate plan follows the new guidelines. If you are truly giving gifts before 2026, you will likely be able to take advantage of this substantial tax benefit and pass more of your estate to your heirs.

Reference: Financial Advisor (May 27, 2022) “Amending The IRS’s Anti-Clawback Provision on Gifting”

 

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Is a Roth Conversion a Good Idea when the Market Is Down?

A stock market downturn may be a prime time for a Roth IRA conversion, reports CNBC’s recent article titled “Here’s why a Roth individual retirement account conversion may pay off in a down market.” This is especially true if you were considering a Roth conversion and never got around to it.

A Roth conversion allows higher earners to sidestep earnings limits for Roth IRA contributions, which are capped at $144,00 MAGI (Modified Adjusted Gross Income) for singles and $214,000 for married couples filing jointly in 2022.

Investors make non-deductible contributions to a pre-tax IRA, before converting funds to a Roth IRA. The tradeoff is the upfront tax bill created by contributions and earnings. The bigger the pre-tax balance, the more taxes you’ll pay on the conversion. However, the current market may make this a perfect time for a Roth conversion.

Let’s say you own a traditional IRA worth $100,000, and its value drops to $65,000. Ouch! However, you can save money by converting $65,000 to a Roth instead of $100,000. You’ll pay taxes on the $65,000, not $100,000.

According to Fidelity Investments, the first quarter of 2022 saw Roth conversions increase by 18%, compared to the first quarter of 2021. That was before the second quarter’s market volatility, which has been more dramatic.

The decision to do a Roth conversion can’t take place in a vacuum. Consider how many years of tax savings it will take to break even on the upfront tax bill. Weigh combined balances across any other IRA accounts, because of the “pro-rata rule,” which factors in your total pre-tax and after-tax funds to determine your tax costs.

Attractive features of the Roth IRA are the freedom to take—or not take—distributions when you want, and there are no taxes on the withdrawals. However, there is an exception, and it pertains to conversions—the five year rule.

If you do a conversion from a traditional IRA to a Roth IRA, you have to wait five years before making any withdrawals of the converted balance, regardless of your age. It’s an expensive mistake, with a 10% penalty. The clock begins running on January 1 of the year of the conversion. If you are close to retirement and will need funds within that timeframe, you’ll need other assets to live on.

However, there’s more. If the conversion increases your Adjusted Gross Income (AGI), it may create other issues. Medicare Part B calculates monthly premiums using Modified Adjusted Gross Income (MAGI) from two years prior, which means a higher income in 2022 will lead to higher Medicare bills in 2024.

Before doing a Roth conversion, evaluate your entire financial and retirement situation.

Reference: CNBC (May 10, 2022) “Here’s why a Roth individual retirement account conversion may pay off in a down market”

 

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Read more about the article Is Succession Planning Necessary for Family Business Entities?
Colleagues Applauding Senior Businessman ca. 2003

Is Succession Planning Necessary for Family Business Entities?

Failing to have a succession plan is often the reason family businesses do not survive across the generations. Creating, designing and implementing a succession plan can protect the family’s legacy, according to the article “Planning for Success: How to Create a Suggestion Plan” from Westchester & Fairfield County Business Journals.

Start by establishing a vision for the future of the business and the family. What are the goals for the founder’s retirement? Will the business need to be sold to fund their retirement? One of the big questions concerns cash flow—do the founders need the business to operate to provide ongoing financial support?

Next, lay the groundwork regarding next generation management and the personal and professional goals of the various family members.

Several options for a successful exit plan include:

  • Family succession—Transferring the business to family members
  • Internal succession—Selling or transferring the business to one or more key employees or co-workers or selling the company to employees using an Employee Stock Ownership Plan (ESOP)
  • External succession—Selling the business to an outside third party, engaging in an Initial Public Offering (IPO), a strategic merger or investment by an outside party.

Once a succession exit path is selected, the family needs to identify successors and identify active and non-active roles and responsibilities for family members. Decisions need to be made about how to manage the company going forward.

Tax planning should be a part of the succession plan, which needs to be aligned with the founding member’s estate plan. How the business is structured and how it is to be transferred could either save the family from an onerous tax burden or generate a tax liability so large, as to shut the company down.

Many owners are busy with the day-to-day operations of the business and neglect to do any succession planning. Alternatively, a hastily created plan skipping goal setting or ignoring professional advice occurs. The results are bad either way: losing control over a business, having to sell the business for less than its true value or being subject to excessive taxes.

Every privately held, family-owned business should have a plan in place to establish what will happen if the owners die or become incapacitated.

An estate planning attorney who has experience working with business owners will be able to guide the creation of a succession plan and ensure that it works to complement the owner’s estate plan. With the right guidance, the business owner can work with their team of professional advisors to ensure that the business continues over the generations.

Reference: Westchester & Fairfield County Business Journals (March 31, 2022) “Planning for Success: How to Create a Suggestion Plan”

 

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What are the New IRA Distribution Rules?

Many of the proposed distribution rules, which will be subject to further action in late spring, depend upon whether or not the original IRA owner died before or after the appliable required beginning date for distributions. As explained in the article “The Internal Revenue Service (IRS) Issues Proposed Minimum Distribution Rules” from The National Law Review, the age changed as a result of the SECURE Act, to 72.

Spousal Beneficiaries. If the spouse of the deceased IRA owner is the sole designated beneficiary and elects not to rollover the distribution, the surviving spouse may take RMDs over the deceased’s life expectancy. However, if the owner died before their required beginning date and the spouse is the sole beneficiary, the spouse may opt to delay distributions until the end of the calendar year in which the owner would have turned 72.

If the decedent died after turning 72, the annual distributions are required for all subsequent years and the spouse may take distributions over the longer remaining life expectancy.

Minor Children Beneficiaries. If the beneficiary of the IRA is a minor child, under age 21, annual distributions are required using the minor child’s life expectancy. When the minor turns 21, they must take annual distributions and the account must be fully distributed ten years after the child’s 21st birthday.

Adult Children Beneficiaries. If the account owner dies after their required beginning date (age 72), an adult child who is a beneficiary must take annual distributions based on the beneficiary’s life expectancy. The account must be completely emptied within ten years of the original IRA owner’s death.

This applies only to adult children who are beneficiaries and are not disabled or chronically ill. Disabled or chronically ill adult children fall into a different category under the SECURE Act, with different distribution rules.

Special Rules for Roth IRAs. The benefits of Roth IRA accounts remain. There are no minimum distributions from a Roth IRA while the account owner is still living. After the death of the Roth IRA owner, the required minimum distribution rules apply to the Roth IRA, as if the Roth IRA owner died before their required beginning date.

If the sole beneficiary is the Roth IRA owner’s surviving spouse, the surviving spouse may delay distribution until the decedent would have attained their beginning distribution date.

If you own IRAs or other retirement accounts, speak with your estate planning attorney to determine if you need to update your estate plan. There are strategies to protect heirs from the significant tax liabilities these changes may create.

Reference: The National Law Review (March 25, 2022) “The Internal Revenue Service (IRS) Issues Proposed Minimum Distribution Rules”

 

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