By Denise Appleby, APA,QKA,CISP,CRC,CRPS,CRSP
The proposed RMD regulations included explanations that differ from industry experts’ interpretation of the SECURE Act. Let’s take a look…
The Treasury Department and the IRS issued proposed regulations on February 24, 2022, to update existing RMD regulations with the changes made by the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act). These proposed regulations include a few surprises that changed the industry interpretation of the SECURE Act. Here, I cover the top four.
1: The ‘ALAR’ rule means annual RMDs under the 10-year rule for some
One of the most impactful changes made by the SECURE Act is to limit the distribution period for designated beneficiaries to a maximum of 10 years. SECURE Act language provides that this 10-year rule works like the 5-year rule, except that it’s 10 years. Recall that under the 5-year rule, distributions are optional until the end of the fifth year that follows the year in which the IRA owner died. The SECURE Act also provides that this 10-year rule applies regardless of whether the deceased IRA owner had already started taking RMDs.
The SECURE Act language led many industry professionals to conclude that regardless of the age at which the IRA owner died, a designated beneficiary could choose whether to take distributions during the first nine years after the IRA owner’s death. However, the proposed regulations explained that the ‘at least as rapidly’ (ALAR) rule continues to apply to all beneficiaries.
Therefore, while a designated beneficiary (who is not an eligible designated beneficiary—see below) is subject to the 10-year maximum distribution period, annual RMDs must be taken by the beneficiary if the IRA owner dies on or after the required beginning date (RBD). These annual RMDs must be calculated using the designated beneficiary’s life expectancy based on the Single Life Table.
This misleading SECURE Act language caused some beneficiaries subject to the 10-year rule to miss their RMDs for 2021, as evidenced by the many complaints sent in response to the request for comments on the proposed regulations.
In response, the IRS issued Notice 2022-53, which provided that the 50% excise tax on missed RMDs is waived for beneficiaries under the 10-year rule and did not take beneficiary RMDs for 2021 and 2022. These are designated beneficiaries, and successor beneficiaries of primary beneficiaries who were taking distributions over their life expectancies.
Planning tip: The distribution options for Roth IRAs are the same regardless of the age of the Roth IRA owner at death. This is because there’s no RMD and no RBD for Roth IRAs. A designated beneficiary may therefore choose to wait until the end of the 10 years to take distributions from an inherited Roth because those distributions would be tax-free. But for traditional IRAs, the beneficiary’s tax advisor should determine whether it makes good tax sense to withdraw more than the minimum during any year before the tenth year.
2: Not more than 10 years younger is not counted by calendar year
The distribution options available to the beneficiary of an IRA are determined by factors that include whether the beneficiary is an eligible designated beneficiary. An eligible designated beneficiary is a designated beneficiary who, at the time of the IRA owner’s death, is:
- The surviving spouse of the IRA owner,
- A child of the IRA owner who has not reached the age of 21,
- Chronically ill, or
- Not more than 10 years younger than the IRA owner.
Traditionally, the IRS counts 10-year periods on a calendar year basis. For example, an IRA owner must generally use the Uniform Lifetime Table to determine the distribution period for calculating RMDs. The Uniform Lifetime Table assumes that the beneficiary is 10 years younger than the IRA owner.
This 10-year-age difference is determined on a calendar basis—for instance, if the IRA owner is age 80, the age used for the beneficiary is 70—and both ages are determined as of the end of the year for which the RMD is being calculated.
This led many industry professionals to interpret the “not more than 10 years younger” qualification based on the ages of the IRA owner and beneficiary as of the end of the years in which they were born. But the proposed regulations explained that when determining if a designated beneficiary is not more than 10 years younger than the IRA owner, the actual dates of birth of the IRA owner and the beneficiary must be used. They provided the following example:
…if an employee’s date of birth is October 1, 1953, then the employee’s beneficiary is not more than 10 years younger than the employee if the beneficiary was born on or before October 1, 1963.
Planning tip: Before the proposed regulations were published, a beneficiary (using the IRS’s example) who was born on October 2, 1963, would likely have been told that they were an eligible designated beneficiary. But according to the proposed regulations, they are—to use Natalie Choate’s phrase —a ‘plain old designated beneficiary’ (PODB). The PODB would be subject to the 10-year rule instead of being eligible to take distributions over their full single life expectancy. If you have clients who are affected by this interpretation of the proposed regulations, you might need to revise any information that was provided to them about their distribution options.
3: The shorter of rule limits distribution periods for older eligible designated beneficiaries
Suppose an IRA owner dies on or after the RBD, and the beneficiary is an eligible designated beneficiary. In that case, distributions must be made over the longer of the remaining single life expectancy of the decedent or the single life expectancy of the beneficiary. However, the distributions cannot extend beyond the life expectancy of the beneficiary. Using the fact pattern from the example provided in the proposed regulations, the following is an example:
- John, a traditional IRA owner, died at age 75—which means he died after his RBD.
- John’s beneficiary is his 80-year-old cousin, Susie. Susie is an eligible designated beneficiary for John’s IRA because she is not more than 10 years younger than John.
- Because John is younger than Susie—and therefore has a longer life expectancy based on the Single Life Expectancy table, his life expectancy of 14.8 years is used to calculate Susie’s annual beneficiary RMDs.
- However, Susie must fully distribute the IRA when her life expectancy—which is 11.2 years based on the example (10.5 based on current regulations)—is less than or equal to one.
Planning tip: Using the example above—if Susie takes no more than her RMDs, she will have a relatively large lump sum at the end of her life expectancy when compared to the other distributions. Her tax advisor should assess whether she should use John’s life expectancy or hers when figuring out how much she should withdraw, even if that is more than her RMD.
4: Documentation requirements for disabled or chronically ill status
If a beneficiary is an eligible designated beneficiary because of being disabled or chronically ill, documentation of the disability of chronically ill status must be provided to the IRA custodian by October 31 of the year that follows the year in which the IRA owner dies. Failure to provide the required documentation by the deadline would result in disqualification from being an eligible designated beneficiary due to being disabled or chronically ill.
For chronically ill beneficiaries, the documentation must include a certification by a licensed health care practitioner of the beneficiary’s chronically ill status.
Generally, a minor child’s eligible designated beneficiary’s status changes to PODB when the child reaches age 21. However, if the child is disabled or chronically ill, the eligible designated beneficiary status is retained after age 21 if the required documentation is provided by October 31 of the year that follows the year in which the IRA owner died.
Planning tip: To avoid the risk of missing this deadline, the documentation can be provided to the IRA custodian before the IRA owner’s death.
Future planning for beneficiaries
Advisors should review distribution plans that were implemented for beneficiaries both before the SECURE Act and after to accommodate for explanations provided in the proposed regulations. Another review might be necessary if the final regulations include material changes that affect beneficiary options.
Reviews should include the determination of whether a beneficiary is a designated beneficiary, an eligible designated beneficiary, or a successor beneficiary—as the distribution options for each are different. A checklist that covers the options for each would help clients stay on the path that applies to each class of beneficiary.
Original title: The Top 4 Shocking Revelations from the Proposed RMD Regulations