IRS Finally Issues Secure Act RMD Regulations

Transcript of Podcast Episode 168

Hello this is Bill Rainaldi with another edition of Security Mutual Life’s SML Planning Minute.  In today’s episode, the IRS finally issues proposed Required Minimum Distribution Rules in response to changes made by the Setting Every Community Up for Retirement Income Act of 2019 (“SECURE” Act).

Well, it took more than two years, but the IRS finally got around to issuing its new RMD rules.

 If you contribute money to a tax-qualified account such as a traditional IRA or a traditional 401(k), you generally get an income tax deduction for the contribution­—up to certain limits.  And there is no income tax due as the account grows.  The income tax is not eliminated. It is simply deferred until you take the money out of the account.  The government, of course, is understandably concerned about when they are going to receive their tax revenue.

 Thus, they created the concept of Required Minimum Distributions or RMDs. Once you get past a certain age, you are required to take some money out of the account and pay the tax on it.  The percentage that you are required to take out goes up each year as you get older, and your actuarial life expectancy goes down.

 Under the SECURE Act, passed in December 2019, the age to begin RMDs was changed from age 70½ to age 72. This was good news for many older taxpayers with IRAs, because it allowed them to continue to get tax-deferred growth on their account for a little bit longer. But the legislation left a number of unanswered questions. At long last, we finally have some answers.

 Prior to the SECURE Act, when a younger person inherited an IRA from someone, they could “stretch” the distributions out from the IRA across their own lifetime, based upon life expectancy tables. Note that in this case, the RMDs would begin within a year of the time they inherited the IRA, regardless of their age. For someone, say, age 30, the RMDs would be small simply because a 30-year-old has a long actuarial life expectancy. Thus, was born the concept of the “stretch” IRA.

 One of most significant consequences of the SECURE Act was the so-called “10-year rule.” The Act eliminated the concept of the stretch IRA and stated that an inherited IRA had to be fully distributed (and thus all taxable income recognized) within 10 years of the original owner’s death.

 But when exactly does this 10-year period start? Under the new proposed rules, the money must be fully distributed by the end of the 10th calendar year after the year of death of the owner. This is actually good news; the initial draft of the SECURE Act seemed to indicate that the clock started on the date of death. Now it can be almost eleven years in some cases.

 One other source of confusion at the time the law passed had to do with exactly how the 10- Year Rule is applied. For example, are RMDs required during the 10-year period, or could you hold off on taking anything until the very end? Ten years of tax-deferred growth could prove to be quite beneficial.

 At the time the law passed, the general interpretation of the SECURE Act was that while distributions could be made at any time during the 10-year period, no distributions were required in years 1-9 following death, and the full balance could be distributed at the end if desired. The new rules confirm this, but with a twist: there is an exception if RMDs have already begun. If RMDs started, say in year one, you must continue them. You do not have the option of postponing the remaining RMDs until the end of the 10-year period.

 There are a few other things that the regulations clarify. For example, minors are generally exempt from the 10-Year Rule. If a child inherits an IRA, he or she can take the relatively small lifetime distributions until they reach the age of majority. Under the new regulations, the “age of majority” for the child of the deceased IRA owner is set at 21, even though it is 18 in most states. So the clock starts ticking on the 10-Year Rule when they get to 21.

 The new rules also address the issue of disability. A disabled person who inherits an IRA is exempt from the 10-Year Rule and is allowed to stretch the payments over his or her lifetime. The new rules make clear that any qualifying disability must be documented by a licensed health care practitioner before the person can take RMDs based on their age.

 Note that there are other significant exceptions to the 10-Year Rule, such as the owner’s spouse or a beneficiary who is not more than 10 years younger than the deceased account owner.  In those circumstances, the beneficiary can choose to either use the 10-Year Rule or take distributions over his or her lifetime.

 The IRS also clarifies how RMDs would apply when there are multiple beneficiaries to a single IRA. This can be especially challenging when the beneficiary is an IRA trust.

 The new rules should help clear up planning issues for many. But note that things are not fully resolved quite yet. Before the regulations become finalized, there will be a 90-day public comment period, followed by a public hearing on June 15 of this year.

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