August 22, 2023
Why Refuse the RMD Relief
Take-Away: While the IRS has provided relief in two Notices to some beneficiaries who have inherited retirement accounts in the past three years, thus relieving them of the obligation to take annual required minimum distributions (RMDs), deferring an RMD may not be a wise move from an overall income tax-savings perspective.
Background: We know that the IRS has granted transitional relief with regard to a beneficiary’s obligation to take a required minimum distribution (RMD) from an inherited retirement account. Last year, in Notice 2022-53, the IRS waived penalties for missed 2021 and 2022 RMDs within the SECURE Act required 10-year distribution period. Recently, the IRS issued Notice 2023-54 that extends that penalty waiver to cover missed 2023 RMDs when the account owner’s death occurred in 2020 or 2021. In addition, the most recent IRS Notice also waives the penalty for missed 2023 RMDs within the 10-year period when the account owner’s death occurred in 2022.
The initial impulse might be for a beneficiary who is subject to the 10-year distribution rule [i.e., the account owner was past his/her required beginning date (RBD) when he/she died] and who would otherwise be required to take an annual RMD for 2023 to take advantage of this option to avoid taking their 2023 RMD, thus permitting more funds to stay in the inherited account to grow tax-deferred. However, that might not be the best decision. A beneficiary who inherits a retirement account who has this option to take advantage of this relief from taking RMDs ultimately still has the 10-year deadline to face. While it might be tempting to skip taking a taxable RMD in 2023, that may lead to a higher income tax bill when the 10th year finally arrives and a taxable distribution must be taken. While the IRS in its Notice provides this ‘relief’ from taking an RMD in 2023, the beneficiary might be better off taking an RMD now, skipping the waiver opportunity, in order to keep the taxable distribution in a lower marginal income tax bracket.
Example: Duncan, age 75, died in 2020. The beneficiary of Duncan’s IRA is his son, Jeff, who is an adult. Jeff is a non-eligible designated beneficiary; accordingly, Jeff is subject to the 10-year distribution rule under the SECURE Act. The proposed Regulations provide that since Duncan died after his RBD, Jeff must take annual RMDs based on Jeff’s single life expectancy during years 1-9 of the 10-year distribution period. Notice 2022-53 provides that even though Jeff failed to take an annual RMD in 2021 or 2022 due to his confusion caused by the proposed Regulation’s ‘surprise’ interpretation of the SECURE Act, there is no penalty imposed on Jeff’s failure to take RMDs for 2021 and 2022. The most recent IRS Notice extends this relief for Jeff’s 2023 annual RMD. In short, because Jeff is eligible for the relief under the two IRS Notices, Jeff does not have to take RMDs during the 10-year period for years 2021, 2022 and 2023, i.e. three years in a row when Jeff does not have to take a distribution from the inherited IRA. However, Jeff may want to take distributions anyway to minimize his income tax obligation in future years, especially if income must be taken in calendar years 2026 and beyond, after the sunset to the 2017 Tax Act and its reduced income tax rates and expanded income tax brackets.
Conclusion: The proposed Regulations with regard to the SECURE Act surprised many when they provided that some beneficiaries had to take annual RMDs from an inherited retirement account if the account owner dies past his/her RBD. These two IRS Notices recognize that this interpretation caught many beneficiaries off-guard, providing some relief to beneficiaries from having to take an annual RMD. Avoiding the penalties is helpful. But it may not be helpful to not take RMDs for three consecutive years, since all that means is that larger taxable distributions will be taken over the following 7 years of the 10-year distribution period.