RMD Relief for Some Beneficiaries

The SECURE Act introduced a new 10-year rule for inherited retirement accounts where the employee or IRA owner died after 2019. Proposed regulations on required minimum distributions (RMDs) for inherited accounts that were issued in February 2022 elaborated on the 10-year rule, but created considerable confusion and controversy. Here are some of the points covered in the proposed regulations (REG-105954-20, 2022-11 IRB 828). References in the following bullets to employees also apply to IRA owners:

• Whether an employee dies before, on or after the employee’s required beginning date, distributions to the employee’s beneficiaries for calendar years after the calendar year of the employee’s death must satisfy the 10-year rule if the beneficiaries are not eligible designated beneficiaries.
• Except for certain surviving spouses who elect to treat the inherited account as their own, the beneficiary of an employee who died on or after the employee’s required beginning date must take an annual RMD beginning in the first calendar year after the calendar year of the employee’s death. In the case of an employee who dies on or after the employee’s required beginning date with a designated beneficiary who is not an eligible designated beneficiary, annual RMDs must continue to be taken by the non-eligible designated beneficiary for up to the first nine years after the year of the employee’s death, with a full distribution required by the end of the 10th calendar year following the calendar year of the employee’s death. A non-eligible designated beneficiary does not have to receive annual RMDs in years 1-9 if the employee died before the required beginning date, but under the 10-year rule, the entire account must be emptied by the end of the 10th calendar year following the calendar year of the employee’s death (so the beneficiary has flexibility during the 10-year period). Roth IRA owners are always considered to have died before their required beginning date, so non-eligible designated beneficiaries of a Roth IRA must fully empty the account by the end of the 10th year following the year of the account owner’s death, but do not have to take RMDs in years 1-9.
• For a designated beneficiary who is an eligible designated beneficiary, the proposed regulations include an exception to the 10-year rule under which the beneficiary can take distributions over his or her life expectancy beginning in the year following the year of the employee’s death. Eligible designated beneficiaries include the owner’s surviving spouse or minor child (but only until age of majority), a disabled or chronically ill individual, or an individual who is not more than 10 years younger than the employee. Under the proposed regulations, if the employee died on or after the required beginning date and an eligible designated beneficiary using the life expectancy method dies before the entire account is distributed, the beneficiary of the eligible designated beneficiary (the successor beneficiary) must continue to take annual distributions after the eligible designated beneficiary’s death for up to nine years, with a full distribution made by the end of the 10th year after the year of the eligible designated beneficiary’s death.

Caution. Proposed regulations technically are not considered “black letter law” until they become finalized. The IRS has made it clear that this is especially the case where so much confusion has existed after the release of the proposed regulations. In early October 2022, the IRS provided some relief to certain beneficiaries in response. First, it made it clear that the final regulations related to the 10-year rule will apply no earlier than the 2023 distribution year. It then provided the following interim relief for 2021 and 2022 (Notice 2022-53).

Relief for 2021 and 2022. Under Notice 2022-53, taxpayers who did not take “specified RMDs” (defined below) from retirement plans, such as 401(k) plans, and IRAs for 2021 and 2022 will not be subject to the 50% penalty, which is an excise tax on the portion of distributions that should have been taken but were not. Any taxpayer who paid the penalty for 2021 may request a tax refund. A specified RMD is any distribution that under the interpretation from the proposed regulations would be made to: A designated beneficiary of an employee under the plan (or IRA owner) if: (1) the employee (or IRA owner) died in 2020 or 2021 and on or after the employee’s (or IRA owner’s) required beginning date, and (2) the designated beneficiary is not taking lifetime or life expectancy payments; or

• A beneficiary of an eligible designated beneficiary (including a designated beneficiary who is treated as an eligible designated beneficiary) if: (1) the eligible designated beneficiary died in 2020 or 2021, and (2) that eligible designated beneficiary was taking lifetime or life expectancy payments. Note that this provision treats a designated beneficiary of an employee (or IRA owner) who died before 2020 as an eligible designated beneficiary.