Retirement plans and individual retirement accounts (IRAs) are subject to required minimum distribution rules under Internal Revenue Codes Section 401(a)(9). The SECURE Act[1] amended the required minimum distribution rules generally effective for distributions after December 31, 2019. The amendments include material changes to the post-death required minimum distribution rules, particularly a new 10-year rule applicable to IRA and retirement plan distributions. The IRS finally issued Proposed Regulations on February 24, 2022 that have left many beneficiaries unclear about their obligation to take a required minimum distribution for 2021 and 2022. Fortunately, IRS notice brings welcome relief by assuring that the Proposed Regulations will not be effective before 2023.
Background
Required Beginning Date
Required minimum distributions (“RMDs”) must commence after an IRA owner (including SEP IRA, SARSEP and SIMPLE IRA owners) or retirement plan participant (each an “Owner”) reaches their “required beginning date”. Prior to January 1, 2020, the required beginning date for IRA owners and 5% or greater owners of employers was April 1 following the year they turned 70 ½. For most plan participants the required beginning date was April 1 following the later of (i) the year they turned 70½; or (ii) the year they retire.
The SECURE Act changed the required beginning date from age 70½ to 72 for IRAs, all tax qualified retirement plans, Section 403(b) plans and Section 457(b) plans. More significantly, the SECURE Act also changed the RMD rules for a large class of designated beneficiaries under tax-qualified defined contribution, 403(b), and 457(b) plans (“DC Plans”).
New Class of Beneficiaries
Prior to January 1, 2020, there were two classes of beneficiaries for RMD purposes: beneficiaries who are not persons (e.g. a charity or an estate) and designated beneficiaries. Designated beneficiaries are individuals who are designated in writing to be beneficiaries of an Owner’s account balance. Beneficiaries who were not designated beneficiaries were required to take a distribution of the entire account balance within the five-year period following the year of the participant’s death (the “5-Year Rule”). Under the 5-Year Rule no distributions were mandated prior to the fifth year. Designated beneficiaries generally were permitted to take distributions over their life or life expectancy with the distributions beginning no later than December 31 of the year following the year of the Owner’s death (subject to an exception where the designated beneficiary is a surviving spouse).
The SECURE Act created a new class of “eligible designated beneficiaries” limited to the Owner’s surviving spouse and minor children[2], non-spouse beneficiaries who are no more than 10 years younger than the Owner, a disabled person under Code Section 72(m)(7) and a chronically ill individual (within the meaning of section 7702B(c)(2). Designated beneficiaries who are not eligible designated beneficiaries are subject to a new 10-Year Rule which effectively eliminates the ability of non-spouse beneficiaries to stretch distributions from retirement plans and inherited IRAs. In addition, beneficiaries of eligible designated beneficiaries are subject to the 10-Year Rule.
New 10-Year Rule
Most practitioners interpreted the new 10-Year rule as (i) working essentially the same way as the 5-Year Rule; and (2) not being subject to the “least as rapidly rule” which requires beneficiaries to receive an RMD that is not less than the RMDs the Owner was receiving prior to the Owner’s death. That is, designated beneficiaries could take partial distributions or no distribution at all so long as the decedent’s entire account balance is distributed by December 31st of the tenth year following the calendar year of the decedent’s death. It was also assumed that a similar approach applied to the beneficiary of an eligible designated beneficiary.
Proposed Regulation Approach to 10-Year Rule
The Proposed Regulations impose a very different approach to the 10-Year Rule. Under the Proposed Regulations where an Owner dies after their required beginning date, designated beneficiaries are required to take distributions in each year of the 10 years using the life expectancy rules previously applied to stretch distributions. Any balance remaining in the tenth year following the Owner’s death must be distributed by December 31 of that year.
Relief Offered by IRS
In Notice 2022-53, the IRS acknowledges the receipt of comments from individuals who became owners of inherited IRAs or beneficiaries under DC Plans due to the death of the IRA owner or plan participant in 2020 or 2021. Most expressed the concern that they thought the 10-Year Rule would operate like the 5-Year Rule with no specific distribution requirement prior to the last year of the period. As a consequence, they did not take an RMD in 2021 and are unsure of whether an RMD is required for 2022 while the IRS regulations remain in proposed form.
While the IRS did not provide any clues into how the final regulations will address the 10-Year Rule, Notice 2022-53 does provide the following relief for any RMD required under the Proposed Regulations (i) in respect of the death of an Owner who died in 2020 or 2021 after their required beginning date, or (ii) in respect of the death of an eligible designated beneficiary in 2020 or 2021 (both “Specified RMDs”):
- No DC Plan or IRA will be in violation of the RMD requirements in 2021 or 2022 for failure to distribute a Specified RMD to a designated beneficiary or beneficiary of an eligible designated beneficiary;
- No designated beneficiary or beneficiary of an eligible designated beneficiary will be subject to an excise tax for failure to take an RMD in 2021 or 2022; and
- The earliest plan year that the RMD final regulations will be effective is 2023.
Beneficiaries, as well as IRA and retirement plan sponsors, their administrators, and recordkeepers can now rest assured that a failure to distribute an RMD for 2021 and 2022 will not be treated as a failure to satisfy the distribution rules under Code section 401(a)(9) and will not trigger 50% excise tax for the beneficiaries. Beneficiaries who did pay an excise tax for a missed RMD in 2021 that is a Specified RMD should request a refund of that excise tax.
[1] Division O of the Further Consolidated Appropriations Act, 2020, Pub. L. 116-94, 133 Stat. 2534 (2019), known as the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act).
[2] Upon attaining the “age of majority” the remaining balance in the Owner’s account must be distributed under the 10-Year Rule.
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