Ed Slott: The IRA Conversation Advisors and Clients Must Have Now

Advisors should take advantage of today’s low tax rates — and “do Roth conversions while taxes are on sale!” according to Ed Slott of Ed Slott & Co.

Every advisor, Slott told ThinkAdvisor Tuesday, “should be having this conversation with their clients. This may only last for the next three years (2023, 2024, and 2025). After that, tax rates are scheduled to revert back up to previous levels.”

We caught up with Slott to get his expert advice on everything from missed required minimum distributions to the debt ceiling fight and its potential impact on Social Security benefits to the IRA advice advisors should be giving their clients now.

THINKADVISOR: What happens when people miss their RMDs?

ED SLOTT: There is a penalty for missing an RMD, both for IRA owners and beneficiaries.

For years, the penalty for a missed RMD had been 50% of the amount not taken. The Secure 2.0 Act changed this beginning this year (2023). The missed RMD penalty is reduced from 50% to 25%. Additionally, the penalty can be further reduced to 10% if the missed RMD is withdrawn during a correction window.

For most people, correction must be made by the end of the second tax year following the year for which the RMD was missed. The RMD would need to be taken and the 10% penalty paid during this window.

But the penalty can also be waived altogether by filing IRS Form 5329. The missed RMD must still be made up and you must provide a reason for the missed RMD, like medical issues, death in the family, confusion on the rules or incorrect advice.

While the changes to the RMD penalty are mostly good news for account holders who miss RMDs, there are still potential issues.

While Secure 2.0 leaves intact previous rules which allow an individual who missed an RMD to take the distribution and then use Form 5329 to request a waiver of the penalty, in the past, the IRS has been agreeable to granting these waivers. But it is unknown whether the IRS will continue their generous waiver policy now that Secure 2.0 has reduced the penalty.

Additionally, requesting a waiver may take some time, and the window could potentially close on the deadline to reduce the penalty from 25% to 10%. Some individuals may decide it is simpler to just pay the 10% penalty and be done with it. In the end, the penalty for a missed RMD may be smaller, but more retirement savers may end up paying it.

Advisors can help by monitoring RMDs for all clients, especially given the recent changes to the RMD rules, for both IRA owners and beneficiaries.

Secure 2.0 also directs the IRS to expand its Employee Plans Compliance Resolution System (EPCRS), which previously only covered employer plan errors, to also cover IRA errors. This provision of Secure 2.0 does not include a great amount of detail.

However, it does specifically mention that the expansion of EPCRS could be used to exempt a missed RMD from the penalty. How EPCRS will dovetail with the missed RMD correction process is still unclear.

Another change to the RMD penalty, effective now under Secure 2.0, is the establishment of a three-year statute of limitations for missed RMDs. That limitations period starts with the tax-filing deadline (not including extensions) for the year for which the RMD is missed. For those who do not file, the deadline would be the deadline for their return had they filed.

Before Secure 2.0, because Form 5329 is considered a stand-alone tax return, the statute of limitations did not start to run until that form was actually filed. This meant the IRS could potentially go back many years to assess a penalty for missed RMDs. Now, the IRS will be limited to a three-year lookback period.

While most IRA owners are aware of their RMD requirements, beneficiaries may not be, especially with the numerous changes to the beneficiary RMD rules in the original Secure Act and the new 10-year rule. These are confusing and beneficiaries will need guidance here.

If you had to, what would you tell clients worried about cuts to their Social Security benefits in 10 years?

My sense is that those who are already collecting or nearing that age should not have to worry.

However, those a few years behind may see some cutbacks in the sense of having to wait longer to collect benefits. In the end though you have to keep in mind that Social Security is unlike other government entitlement programs, since workers have paid in for decades and have earned these benefits.

It will be a tough hill for Congress to climb to make any significant cuts in these earned benefits.

If nothing is done about our nation’s current fiscal situation (which seems likely, given that Congress can’t seem to ever come to a consensus on this), then younger workers should not consider Social Security a solid part of their retirement plans.

They will need to do most of that on their own, by amping up contributions to their various retirement plans (especially Roth IRAs since these funds will grow tax-free for them), and other savings outside of retirement.

At some point, these younger workers will find themselves in a YOYO economy with the respect to saving for their retirement years (YOYO = you’re on your own!).

The IRS’ final Secure Act regulations still haven’t been released. Any thoughts? Are you expecting them soon? 

There is no telling when that will be, but it does not appear that we will see them soon, or before year-end. The proposed regs issued last year (February 2022) contained guidance and major updates that are in force now, leaving IRS some breathing room to work on the final regs.

In addition, Secure 2.0 has some issues that need timely clarification and correction before year-end, so that may take precedence at IRS.

What should advisors be telling (or warning) their clients about IRAs now?

Lots of recent IRA tax rule changes to be aware of:

• RMD confusion — RMD age changed from 70 ½ to 72, and now to 73, so many are confused as to which age applies.
• New RMD penalty relief (see above);
• Beneficiary RMD confusion is rampant given the elimination of the stretch IRA, creation of the 10-year payout rule, and which beneficiaries can still use the stretch IRA;
• New Roth opportunities expanded with Secure 2.0 — Roth SEP-IRAs, Roth SIMPLE IRAs, Roth plan matching contributions and catch-up contributions, and 529 to Roth rollovers;
• Inflation has increased the contribution amounts for IRAs and 401(k)s — For example, those age 50 or over can now contribute up to $30,000 ($22,500 + $7,500 catch-up) to company retirement plans like 401(k)s, 403(b)s, etc.
• The backdoor Roth is still viable for those with income above the Roth IRA contribution limits. This was on the chopping block but never made it into any of the recent tax laws.
• A slew of new exceptions to the 10% penalty for early distributions may entice early withdrawals — but this is no free lunch. These distributions are still taxable and will erode retirement savings.

Advisors should warn clients that withdrawing early from IRAs and other retirement plans will leave them with less for their retirement years. Even though the penalty exception rules have been expanded, withdrawing early should be a last resort.

How, and should, advisors help clients with dementia set up automatic RMDs?  Will the IRS waive penalties if or when RMDs are missed by those with dementia? How can advisors best help families with these issues?

The IRS can waive RMD penalties for medical reasons, but advisors may need to step in and help set up a plan when a client forgets to take RMDs.

This may have to be done with a family member or other client advocate. They’ll need to have an updated Power of Attorney to allow them to take RMDs for them.

Many recent POAs already have this provision so check that. If the client is already mentally diminished, then they may no longer be competent to execute a POA. That’s why all advisors should encourage clients to do this now, when they are able. You never know when you might need this.