Bob’s Journal for 10/13/22

IRS Waives Some Penalties on Inherited IRAs

The IRS issued proposed regulations in February 2022 that surprised a lot of tax advisors and indicated a number of heirs incurred penalties for not taking actions they didn’t know about.

Late last week, the IRS said it would waive those penalties for 2021 and 2022. The proposed regulations were issued under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted in 2019.

I reviewed the regulations in the May 2022 issue of Retirement Watch. The SECURE Act states that, except in a few cases, a beneficiary who inherits an IRA (either a traditional or a Roth IRA) must distribute the entire IRA within 10 years.

Before the proposed regulations, most tax advisors believed this meant the beneficiary could distribute the IRA in any pattern he or she wanted, as long as it was fully distributed within the 10 years.

The 10-year rule is interpreted differently under the proposed regulations.

If the deceased owner hadn’t reached his required beginning date (RBD) for required minimum distributions (which is April 1 of the year after he or she turns age 72), then the beneficiary can take the distributions however he or she wants as long as the IRA is fully distributed within 10 years.

But if the IRA had reached the RBD, then the beneficiary must take at least minimum annual distributions in each of the first nine years after inheriting the IRA. The remainder of the IRA must be fully distributed by the end of the 10th year.

The annual distributions during the first nine years are determined using the pre-SECURE Act rules, which generally means the distributions are computed using the beneficiary’s life expectancy.

There are more details about this rule and how to compute the required distributions in my report “Bob Carlson’s Guide to Inheriting IRAs,” available through the website or by calling 800-552-1152.

The proposed regs indicate that they are effective, as of the date the SECURE Act took effect in 2020, though the regulations weren’t issued until February 2022. That means some IRA beneficiaries were required to take distributions in 2021 and 2022. They didn’t know about the requirement but still would owe penalties for not taking the distributions.

That’s why the IRS last week said it would waive the penalties for 2021 and 2022 for beneficiaries who didn’t take the distributions as required under the proposed regulations. The IRS also said that anyone who already paid a penalty for not taking a distribution can apply for a refund of that penalty.

But the IRS did not say that someone who did take a distribution in 2021 or 2022 because of the proposed regulations can return that money to the IRA or claim a refund of taxes paid on the distributions.

Under the IRS notice, the first distributions don’t have to be taken until 2023 and perhaps later, depending on what the final regulations say.

The IRS also indicated that it plans to finalize the regulations soon, perhaps by the end of 2022 or in early 2023.

A number of tax professionals who commented on the proposed regulations asked the IRS to change its interpretation of the 10-year rule to the one that was widely accepted before the proposed regulations were issued.

The wording of the penalty waiver doesn’t give a hint how the IRS will respond in the final regulations. Some tax professionals say waiving the penalties means the IRS is likely to change its interpretation. Others say it means the IRS plans to continue its interpretation but realizes imposing it retroactively is unfair.

But the announcement gives IRA owners and beneficiaries more time to plan IRA distributions.

The proposed regulations show the importance of long-term IRA distribution planning. As I’ve explained, long-term planning for IRAs can reduce the total taxes a family pays on IRA balances and increase a family’s after-tax wealth.

A starting point is to consider the strategies discussed in the April and May 2020 issues of Retirement Watch.

The Next Crisis is Here

The Federal Reserve increased interest rates in 2022 at one of the fastest paces ever.

Rapid, unexpected interest rate increases and money supply tightening often lead to one or more crises. Investors and businesses that took risky actions, assuming there would be no change in policies, can find themselves in distress.

That distress can spread to others, such as their lenders and investors. Sometimes the problem is contained, but sometimes it spreads, as happened in the financial crisis.

The first crisis from the global central bank tightening began in late September in the United Kingdom.

A number of corporate pension funds in the United Kingdom had implemented a strategy known as liability-driven investment (LDI). The U.K. pension funds use a more leveraged LDI strategy than U.S. pension funds use.

A surge in bond market interest rates, caused partly by the release of a new government budget plan, triggered automatic sales of bonds or capital calls on pension funds under the LDI strategies. The U.K. government bond market became illiquid.

A number of investment funds that implement LDI strategies for pension plans reportedly told the Bank of England that if it didn’t restore order to the bond market, the funds would have negative values and be forced to liquidate. That could have resulted in a self-reenforcing downward spiral in the markets.

The Bank of England stepped in to buy bonds to restore liquidity to the market. The central bank continues to buy bonds and other assets to stabilize the markets.

There were rumors that the problem put several large international banks at risk of failure.

The bond-buying program forced the Bank of England to pause the tightening of monetary policy it was engaging in to bring down inflation.

As interest rates increase and liquidity is withdrawn from the economy and markets, asset prices will decline. The declines could lead to defaults and other problems.

The difficulty for investors is that we’re never able to identify the source of a crisis until it occurs. We don’t know how far this crisis will spread and what the next crisis will be.

As Warren Buffett said, we don’t know who’s swimming naked until the tide goes out.

That’s one reason I recommend that your portfolio always be diversified. It’s also a reason I continue to recommend having some gold in your portfolio.

Be Sure to Document All Charitable Contributions

Over the years, Congress tightened the proof required to claim the tax benefits of charitable contributions, and taxpayers who don’t follow the rules are being hurt.

One of the rules requires that before filing a tax return claiming the tax benefit, a taxpayer must have in hand a contemporaneous written acknowledgement from the charity. The document must state the amount and date of the contribution. It also must say that the contributor didn’t receive anything of value from the charity in return for the contribution.

The rules apply to all kinds of tax benefits from charitable contributions. That means if you make a qualified charitable distribution from your traditional IRA, you need the written acknowledgement though you don’t deduct the contribution. Without the document, the distribution must be included in your gross income.

I continue to see a regular stream of Tax Court cases in which all parties agree that a charitable contribution was made. But because the donor didn’t have all the right paperwork, the tax benefits of the contributions are denied.

In one recent case, the taxpayer had a letter from the charity acknowledging the date and amount of the gift. But the letter didn’t state that nothing of value was received in return for the contribution. So, the tax benefits weren’t allowed.

Be sure to have all the required documentation for this year’s charitable contributions before you file the income tax return for the year. Otherwise, you’re at risk that the IRS will deny the tax benefits of the contribution.

The Data

The Producer Price Index (PPI) increased 0.4% in September, which compares to a 0.2% decline in August. Over 12 months, the PPI increased 8.5%.

The core PPI, which excludes food and energy, increased 0.3% in September, the same as in August, and 7.2% over 12 months.

The Small Business Optimism Index from the National Federation of Independent Business (NFIB) inched higher for the third consecutive month to the highest level in four months. The index was 92.1 in September, up from 91.8 in August. The index was 98.9 last December, and just below 105 in late 2020.

The number of business owners reporting that they couldn’t fill job openings declined by three percentage points to 46%. The number that reported inflation as their top problem increased by one percentage point to 30%.

Last week’s Employment Situation reports estimated that 263,000 new jobs were created in September. That was the lowest number of new jobs since April 2021. In the first eight months of 2022, the number of new jobs each month averaged 439,000.

The numbers indicate the labor market still is strong, but it is weakening.

Average hourly earnings increased 0.3% in September and 5.0% over 12 months.

Consumer credit increased at an annual rate of 6.8% in August, down from the 8.4% increase in July. Revolving credit (mostly credit cards) increased in August but nonrevolving credit (mostly vehicle and student loans) declined.

New unemployment claims increased by 29,000 to 219,000 in the latest week.

Continuing claims increased to 1.361 million from 1.346 million.

The Markets

The S&P 500 fell 5.35% for the week ended with Tuesday’s close. The Dow Jones Industrial Average lost 9.06%. The Russell 2000 retreated 4.70%. The All-Country World Index (excluding U.S. stocks) decreased 6.04%. Emerging market equities tumbled 5.52%.

Long-term treasuries lost 3.55% for the week. Investment-grade bonds fell 3.05%. Treasury Inflation-Protected Securities (TIPS) declined 1.09%. High-yield bonds decreased 2.80%.

On the currency front, the U.S. dollar gained 2.87%.

Energy-based commodities increased 1.06%. Broader-based commodities lost 0.64%. Gold declined 3.45%.

Bob’s News & Updates

My next book will be “Retirement Watch: The Essential Guide to Retiring in the 2020s.” The official publication date is Jan. 3, 2023. You can make a pre-publication order or learn more about the book by clicking here and here, respectively.

My latest book is “Where’s My Money: Secrets to Getting the Most out of Your Social Security.” I has received mostly five-star reviews on Amazon for telling you clearly what your benefit options are in different situations and how to determine the best choice for you. You can find it on Amazon.com or Regnery.com.

The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. You should sign up because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Series, click here.

A recent five-star review of my book, “The New Rules of Retirement” on Amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”

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