Americans hold a considerable percentage of their wealth in retirement accounts. Recent changes to the Internal Revenue Code (the “Code”), as well as proposed regulations, have introduced new rules altering the required minimum distribution (“RMD”) rules for plan participants and their beneficiaries alike. One such rule is the 10-Year Rule, which generally requires the beneficiaries of retirement accounts for those participants who died beginning in 2020 to withdraw the entire amount of the retirement account by the end of the 10th year following the year of the participant’s death.

In the two years since the 10-Year Rule was introduced, the consensus was that beneficiaries were not required to take RMDs during the pendency of the 10-Year Rule. Instead, it was thought they were only required to withdraw the entire account balance by year-end of the 10th year following the year of the participant’s death. However, proposed regulations issued in February 2022 provided otherwise where the participant died after their Required Beginning Date, which is generally April 1 of the year following the year in which the participant turns 72.

A new IRS Notice reiterates the surprising position taken in the proposed regulations that these beneficiaries must take RMDs during the term of the 10-Year Rule, but it also provides penalty relief for beneficiaries who did not take them in 2021 or 2022.

The (Very) Basics of the Required Minimum Distribution Rules

Section 401(a)(9) and its related regulations contain rules for when RMDs must be taken from retirement accounts and how the amount of those RMDs is to be determined. These rules are incorporated by reference in other sections of the Code as well, namely § 408(a)(6) and (b)(3), § 408A(c)(5), § 403(b)(10), and § 457(d). As a result, the § 401(a)(9) RMD rules apply to qualified plans, IRAs, Roth IRAs, 403(b) plans, and eligible deferred compensation plans.

For the sake of simplicity, in this blog post we will refer to all the different types of plans and accounts as “retirement accounts,” and the owner or plan participant of these accounts as the “Participant.” Keep in mind, however, that this is a simplification, and there are specific rules and exceptions applicable to the different types of retirement accounts, which can trip up even experienced attorneys.

Annual RMDs must be taken from retirement accounts beginning generally at the earlier of the year following the year in which the Participant turns 72 (as of 2020) or the year following the Participant’s death (the “Required Beginning Date”). Note, Roth IRAs are generally excepted from this rule during the Participant’s lifetime.

During their life, the Participant must take RMDs based on their own life expectancy, as calculated using IRS tables. After death, a beneficiary will be subject to one of five RMD regimes depending on the circumstances (and sometimes multiple RMD regimes): (1) the surviving spouse’s life expectancy, (2) the nonspouse beneficiary’s life expectancy, (3) the Participant’s life expectancy, (4) the “5-Year Rule”, and (5) the “10-Year Rule.”

Under the RMD rules in effect before the SECURE Act’s January 1, 2020 effective date, there were two types of beneficiary once the Participant died: (1) designated beneficiaries and (2) non-designated beneficiaries.

Designated beneficiaries were individuals and certain qualifying “see-through” trusts with individuals as their beneficiaries. Non-designated beneficiaries were every other type of non-individual beneficiary, including charities.

If the beneficiary was a designated beneficiary, then the beneficiary would be required to take RMDs every year based on some life expectancy, depending on the identity(ies) of the beneficiary(ies), for up to the rest of their life. If the beneficiary was a non-designated beneficiary, then which RMD regime applied depended on whether the Participant died before or after their Required Beginning Date. The rules for non-designated beneficiaries remain the same today.

If the Participant dies before their Required Beginning Date, then the 5-Year Rule applies, and the non-designated beneficiary must withdraw all of the benefits by the end of the 5th year following the year of the Participant’s death (or the 6th year for deaths in 2015–2019, thanks to the CARES Act, which waived 2020 RMDs). During the pendency of the 5-Year Rule, the non-designated beneficiary is not required to take any RMDs. Instead, the beneficiary can allow the account to continue to grow on a pre-tax basis, making only a single lump sum withdrawal of the entire amount at the end of the period.

If the Participant dies on or after their Required Beginning Date, then the non-designated beneficiary must take RMDs over what would have been the Participant’s remaining life expectancy.

The SECURE Act and the 10-Year Rule

The SECURE Act made significant changes to the post-death RMD rules starting in 2020.

First, a new class of designated beneficiary was introduced: the eligible designated beneficiary. Eligible designated beneficiaries include the Participant’s surviving spouse, the Participant’s minor child, a disabled or chronically ill individual, an individual not more than 10 years younger than the Participant, and certain qualifying “see-through” trusts with these individuals as their beneficiary. For our purposes here, it is enough to know eligible designated beneficiaries still take RMDs every year based on some life expectancy, similar to the pre-SECURE Act rules for designated beneficiaries, with some qualifications.

Second, the 10-Year Rule was created. The 10-Year Rule applies to designated beneficiaries who are not eligible designated beneficiaries (i.e., every other individual or “see-through” trust). Under the 10-Year Rule, whether the Participant dies before or after their Required Beginning Date, their designated beneficiaries must withdraw the entire account by the end of the 10th year after the year of the employee’s death.

The fact that the 10-Year Rule sounds a lot like the 5-Year Rule, but with a longer duration, is no coincidence. The 10-Year Rule was added to § 401(a)(9) by specifically applying the existing 5-Year Rule to designated beneficiaries who are not eligible designated beneficiaries and substituting 10 years for 5 years. As a result, because beneficiaries are not required to take RMDs under the 5-Year Rule, consensus was that designated beneficiaries would similarly not be required to take RMDs under the 10-Year Rule. Because not taking RMDs for the longest period possible allows for continued pre-tax account growth and tax deferral, it was generally advisable for beneficiaries subject to the 10-Year Rule not to take RMDs and only make the required full withdrawal of the account at the end of the period.

Proposed Regulations and IRS Notice 2022-53

However, when the Treasury Department and the IRS published proposed regulations for the SECURE Act on February 24, 2022, they directly contradicted the consensus, creating confusion amongst practitioners and beneficiaries alike. The proposed regulations provide that if the Participant dies after their Required Beginning Date, then the Participant’s designated beneficiaries, who are subject to the 10-Year Rule, must both take RMDs annually and make the required full withdrawal of the account at the end of the 10th year following the year of the Participant’s death.

The issue arising in the wake of these proposed regulations is the vast majority of beneficiaries subject to the 10-Year rule did not take RMDs in 2021 and were waiting on more concrete guidance for 2022.

The Notice brings much needed clarity to the situation, though not a favorable change of course. First, the Treasury Department and the IRS intend to issue final regulations — presumably with the same 10-Year Rule RMD rules as the proposed regulations — which will apply no earlier than 2023.

Second, and importantly for beneficiaries wondering whether they will be penalized for not following an RMD rule they were unaware existed for the past two years, the Notice provides that if the Participant died in 2020 or 2021 after their Required Beginning Date, then the Participant’s designated beneficiaries who are subject to the 10-Year Rule will not have to pay the 50% excise tax penalty normally imposed for failing to take RMDs in 2021 or 2022. Interestingly, the Notice does not say whether these beneficiaries must take “catch-up” RMDs for those years, so in the absence of any penalty, it is possible any missed 2021 or 2022 RMDs need not ever be taken.

It is worth noting that while the Notice states the Treasury Department and IRS intend to issue final regulations, it is no guarantee they will. While proposed regulations are not binding until finalized, and some proposed regulations have been in proposed form for decades, they do provide rules the IRS is inclined to follow, particularly when they raise revenue. As a result, at least until more guidance is issued, it appears the best practice is to follow the proposed regulations discussed here and take RMDs on an annual basis beginning in the year following the participant’s death.

This is an ever-evolving area of tax law, and it is one full of exceptions, special rules, and nuance. Creating a plan for your retirement accounts which compliments your broader estate planning goals while navigating these complexities requires a sophisticated approach. Complying with such a plan after death requires immediate consideration.