SECURE Act 10-Year Rule – No Penalties

Take-Away: While the IRS provided relief from the 50% excise tax to those designated beneficiaries who did not take a required minimum distribution from an inherited IRA if the IRA owner was age 72 or older, it provided no relief to those individuals who were conservative and knowledgeable and who took a distribution for 2021 and earlier in 2022 and paid the income tax on what they received from the inherited IRA.

Background: As was recently reported, in IRS Notice 2022-53 issued on October 7, 2022, the IRS said that no penalties (an excise tax of 50%)  will apply to a designated beneficiary’s failure to take 2020 and 2021 required minimum distributions (RMDs) due to the IRS’ delay in publishing its Proposed Regulations to the SECURE Act until February, 2022, long after the 2019 SECURE Act became law.

These Proposed Regulations contained  a surprise in that they provided by example that if the IRA owner was in-pay status, i.e. the IRA owner was age 72 or older and thus subject to taking annual RMDs, that the designated beneficiary of the inherited IRA must take annual RMDs, using the designated beneficiary’s own life expectancy in years 1 through 9, and in the 10th year (starting with the year after the IRA owner’s death)  the entire inherited IRA balance had to be distributed. In other words, there will be annual RMDs based on the age of the designated beneficiary of the inherited IRA in years 1 through 9 following the IRA owner’s death, and subsequently a complete liquidation of the inherited IRA to the extent of its assets in the 10^th year.

Example: Doug dies on September 20, 2022. Doug died after age 72, so Doug’s IRA was in-pay status, and he was subject to the RMD requirement. Doug named his daughter Flo as the beneficiary of his IRA. Payments from Doug’s IRA to Flo are subject to the SECURE Act’s 10-year rule. Flo must take annual required minimum distributions in each of the 9 years that follow the year of Doug’s death, based upon what would have applied under the pre-SECURE Act rules. All remaining assets in the inherited IRA must be distributed to Flo by December 31, 2032.

10-year and 5-Year Rule: Many individuals reasonably believed that the SECURE Act’s 10-year distribution rule would be nearly identical to the Tax Code’s pre-existing 5-year distribution rule. The 5-year distribution rule has historically applied when an IRA owner died before his/her required beginning date (RBD) with no designated beneficiary, such as an IRA left to a non-individual beneficiary, e.g. charity; probate estate; non-see-through trust. Under the 5-year distribution rule, all assets must be distributed from the inherited IRA no later than December 31^st of the 5^th calendar year that follows the death of the IRA owner, with no distributions required to be made from the IRA until that December 31.

Example: Todd dies on September 30, 2022, before Todd’s RBD. Todd fails to name an individual beneficiary of his IRA. All assets from Todd’s IRA must be distributed from Todd’s IRA by December 31, 2027, but no distributions will be required from that IRA prior to December 31, 2027.

At-Least-as-Rapidly: Under the Tax Code’s 5-year distribution rule, the beneficiary of the decedent’s IRA would be allowed, but not required, to make withdrawals prior to the 5-year anniversary date. However, if the IRA owner died after his/her RBD (now age 72) then the delay-in-taking rule does not necessarily apply to any of the IRA owner’s beneficiaries; instead, the  required minimum distributions  come out over the deceased IRA owner’s life expectancy, known as the At Lease As Rapidly Rule with annual distributions to the beneficiary.

Mistaken Belief: Many individuals, or more accurately their advisors, believe the IRS’ recent interpretation under the Proposed Regulations is unfair and was not intended by Congress. The parallel 5-year distribution rule has been in effect for decades, and the 5-year distribution rule has never been interpreted or construed in such manner by the IRS. Apparently, however,  the IRS is sticking by its interpretation to apply the ‘At-Least-As-Rapidly’ rule, while acknowledging and granting  penalty relief to those beneficiaries of inherited IRAs  who thought that the 10-year distribution rule would be interpreted comparable to the long-standing 5-year distribution rule.

The following chart illustrates the RMD rules that apply depending on whether the IRA owner dies before or after reaching his/her required beginning date, and whether the beneficiary of the IRA qualifies as either an (i) eligible designated beneficiary, or a (ii) designated beneficiary, or a (iii) non-designated beneficiary.

Conclusion: The IRS’s Notice provides comfort to those individual designated beneficiaries who are subject to the 10-Year Distribution Rule who did not take RMDs in 2021 and/or 2022 that otherwise were required to do so under the Proposed Regulations and their interpretation of the ‘As-Lease-As-Rapidly Rule.’ However, those individual designated beneficiaries  who actually took RMDs for 2021 and/or 2022 must pay the income tax on the distributions that they received from the inherited IRA. The Notice is silent on allowing those individuals who took distributions and paid the income tax to repay any such required minimum distributions into the applicable inherited IRA and receive any refund of any income taxes previously paid on such distributions to allow those individuals to be restored to their prior status equal to those beneficiaries who delayed taking a distribution.