February 17, 2023
SECURE Act Regulations
Take-Away: A deeper dig into the Proposed Regulations for the SECURE Act lead to the conclusion that the new 10-year distribution rule is even more confusing than originally thought.
Background: A lot of missives have been written since February when the IRS released its Proposed Regulations for the SECURE Act. I apologize, in advance, for yet one more missive on the Proposed Regulations. To be honest, these Regulations are even more bewildering than originally thought.
Effective Date: It is important to keep in mind that these Regulations, albeit Proposed, are binding and will apply to the determination of required minimum distributions (RMDs) starting in 2022, even though the Regulations are not yet finalized.
Head Spinning Points and Examples: What follows are some of the key points (or changes) contained in the Proposed Regulations that we need to learn when we (try to) answer questions with regard to RMDs.
1. At-least-as-rapidly Rule: This rule requires annual RMDs to continue once they have started; this rule cannot be ‘turned off.’ [IRC 401(a)(9)(B).] This rule kicks in when the account owner dies after his/her Required Beginning Date (RBD, age 72.) As such, when a non-eligible designated beneficiary inherits a retirement account from another who dies on or after April 1 of the year after he/she turns age 72, that non-eligible designated beneficiary will be subject to both the (i) 10-year ‘empty the inherited account’ rule; and (ii) the at-least-as-rapidly annual RMD rule, using the designated beneficiary’s life expectancy to calculate the RMD. The upshot is that annual RMDs are required during the 10-year payout period. This rule also can apply in other situations as well.
Example: Bud dies at age 74, after Bud’s required beginning date (RBD.) Bud names his older sister, Sandy, age 80, as the designated beneficiary of Bud’s IRA account. Since Sandy is not more than 10 years younger than Bud, Sandy is an eligible designated beneficiary, who can elect to stretch her RMDs. However, since Bud died after his RBD, and Sandy is older than her brother, Sandy is permitted to use Bud’s single life expectancy to calculate her RMDs. Bud’s life expectancy in the year of his death (as a 74 year old) is 15.6 years. For each subsequent year, Sandy subtracts 1 each year. Thus, Bud’s IRA should last for 15 years until Sandy is age 95. However, even though Sandy is using Bud’s life expectancy factor (15.6) to calculate her annual RMDs as an eligible designated beneficiary, Sandy must also monitor her own life expectancy factor to determine when she must empty the inherited IRA. Had Sandy used her own life expectancy to calculate RMDs she would have started with 10.5 years (the factor the year after Bud’s death, or age 81. Eleven years later, Sandy’s own life expectancy would have been down to 0.5 years. Since 0.5 year is less than one, Sally is required to empty the inherited IRA from Bud at her age 91, even though Bud’s life expectancy factor still had 4 years remaining.
2. Hypothetical RMDs: We know that a surviving spouse is treated as an eligible designated beneficiary. Sometimes that survivor is required to take a ‘hypothetical retroactive RMD.’ As an eligible designated beneficiary, the survivor can elect the 10-year distribution rule, instead of the stretch RMD rule if the death of the spousal account owner occurred before his/her RBD. However, the Regulations create a ‘hypothetical RMD’ as a deterrent to make sure RMDs are not avoided by the survivor who would have otherwise been required to take those RMDs upon reaching age 72. Again, the IRS relies on the at-least-as-rapidly rule to get to this result. Thus, if the IRA owner dies before his/her RBD, and the beneficiary is an eligible designated beneficiary, the terms of the IRA agreement may include a provision that allows the eligible beneficiary to choose either the 10-year distribution rule or the life expectancy rule, or default to each. If the IRA agreement is silent on this issue, the Proposed Regulations default to the life expectancy rule.
Example: Joy and Lou are both 70 years old. Lou dies with Joy as his primary IRA beneficiary. As an eligible designated beneficiary, Joy can make a spousal rollover or she can elect to remain the beneficiary of Lou’s IRA. If Joy elects to remain a beneficiary, she can elect the 10-year payout. Since Lou died before his RBD, Joy would have no RMDs during that 10-year window period after Lou’s death. However, if Joy later decides to do the spousal rollover, she may not be able to roll over the full amount from Lou’s inherited IRA. Before completing the spousal rollover, Joy must calculate hypothetical RMDs for each year that she was age 72 or older. These hypothetical RMDS apply retroactively and are not eligible for rollover treatment. (The years before Joy was age 70 and 71 are not considered, because they were before Joy’s first RMD year.) [Proposed Regulation 1.401(a)(9)-5(d)(1)(ii).]
3. Successor Beneficiaries: If the IRA owner dies on or after his/her RBD and the beneficiary is a designated beneficiary or an eligible designated beneficiary, successor beneficiaries must continue to take distributions that the designated beneficiary, or eligible beneficiary was schedule to take. In short, the successor beneficiary does not start a new 10-year period for taking distributions on the death of the designated, or eligible, beneficiary. [Proposed Regulation 1.401(a)(9)-5(d)(1).]
4. Minor Beneficiaries: The minor beneficiaries of the deceased IRA owner, as eligible designated beneficiaries, switch to the 10-year distribution rule when they attain age 21, or they die.
5. Surviving Spouses: If the deceased IRA owner names his/her spouse as beneficiary, as an eligible designated beneficiary, the survivor will begin to take annual life expectancy distributions generally to begin by December 31 of the year that follows the IRA spouse-owner’s death. However, that starting date can be deferred until the year that the deceased spouse would have reached age 72 if that is later and the owner died before reaching their RBD.
6. Trusts as Designated Beneficiaries: With an accumulation trust, if the trustee could accumulate some or all of the distributions from an inherited IRA, subsequent and remainder beneficiaries were ‘counted’ as beneficiaries. Thus, for example, if a charity was named as a remainder beneficiary or even a contingent remainder beneficiary, the IRA owner was treated as having no designated beneficiary, because IRA assets could be accumulated and subsequently paid to the charity.