IRS Surprises with New Proposed Regulations on RMDs
Episode 178 – The IRS issued SECURE Act proposed regulations earlier this year. The new rules, while not finalized yet, contain surprises that were not apparent at first glance, especially when it comes to RMDs.
Transcript of Podcast Episode 178
On December 20, 2019, the “Setting Every Community Up for Retirement Enhancement” Act (SECURE Act) was enacted into law. Over two years later, on February 23, 2022, the IRS issued proposed regulations with respect to required minimum distributions. These proposed regulations have surprised many tax advisors. While these are just proposed regulations, and further changes may occur in the future, most tax advisors agree the changes are essentially effective now.
First, let’s set the stage and define some terms. We should all know by now the SECURE ACT changed the age when nearly all qualified plan and IRA participants–with some exceptions–will be required to take mandatory distributions from their accounts. These are known as “required minimum distributions” or RMDs. RMDs are required by April 1st of the year following the calendar year in which the participant attains the age of 72, an increase from age 70 ½ before the SECURE Act. This is known as the required beginning date or RBD. Also, during this discussion, we exclude Roth IRA accounts which operate under a different set of rules.
IRA owners can leave their traditional IRAs, upon death, to their designated beneficiaries. These are known as inherited IRAs. Prior to the SECURE Act, designated beneficiaries could take RMDs over their life expectancies. Spouses inheriting IRAs from a deceased spouse had the further option to take the IRA as their own and continue it. For young beneficiaries, an inherited IRA allowed for many years and potentially many decades of continued tax-deferred growth. This was known as the “Stretch IRA” concept used by many who did not need the inherited IRA assets for their own financial needs.
The SECURE Act eliminated the Stretch IRA concept. For years 2020 and later, the remaining account balance of an inherited IRA must be distributed to designated beneficiaries within 10 years after the date of death, unless the designated beneficiary qualifies as an “eligible designated beneficiary,” a new term created by the SECURE ACT. This is commonly known as the 10-year rule. Eligible designated beneficiaries include the spouse, a disabled or chronically ill beneficiary and a beneficiary who is not more than 10 years younger than the decedent IRA owner. Eligible designated beneficiaries can continue to take distributions from inherited accounts over their life expectancies, subject to certain other rules that we won’t discuss here.
Since the passage of the SECURE Act, most tax professionals and indeed, the IRS itself, interpreted the 10-year rule to mean that when the participant died, the beneficiary did not need to take any distributions from the IRA until the end of the 10th year following the participant’s death. In the 2021 version of IRS Publication 590-B, the IRS advises: “The 10-year rule requires the IRA beneficiaries who are not taking life expectancy payments to withdraw the entire balance of the IRA by December 31 of the year containing the 10th anniversary of the owner’s death. For example, if the owner died in 2021, the beneficiary would have to fully distribute the IRA by December 31, 2031. The beneficiary is allowed, but not required, to take distributions prior to that date (emphasis added).”
On February 23, 2022, the IRS released the proposed regulations. The big surprise in these proposed regulations is how the IRS now interprets the 10-year rule. If the plan participant died on or after their required beginning date (i.e., age 72), then under the 10-year rule, the designated beneficiary is required to take required minimum distributions in years one through 9, based on their life expectancy, and the remaining account balance in year 10. If the plan participant died prior to their required beginning date, then under the 10-year rule, the designated beneficiary is not required to take RMDs but must take the account balance out by the end of year 10.
What that means is that the proposed regulations reinstall different rules dependent upon whether the IRA owner died before, or on or after, the required beginning date – something that most tax advisors thought the SECURE ACT was trying to avoid. In addition, and perhaps more troublesome, some beneficiaries who may have inherited an IRA in 2020, may have already missed a RMD distribution in 2021 even though they didn’t know they had to take it.
What’s the remedy? For now, that is unknown, and it is best to speak with your tax advisor. Perhaps the IRS will provide further guidance soon. Also, we hope that the IRS will waive the 50% penalty for failure to take an RMD. Stay tuned.
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