10 Questions Answered on IRAs, RMDs & Tax codes

Answer: John, age 75, has a traditional IRA. He dies with his sister Kathy as his primary beneficiary and Kathy’s children (John’s nephews) named as contingents. Kathy, age 72, qualifies as an eligible designated beneficiary (EDB) because she is not more than 10 years younger than John. Eight months later, before completing any paperwork to claim the account, Kathy dies. The assets do NOT pay to the contingent nephews. Kathy, as an EDB, is deemed to have created an inherited stretch IRA. The custodial document identifies her estate as default beneficiary. An estate-owned inherited IRA is established. Since Kathy was an EDB and allowed to stretch RMD payments, the estate, as successor, receives a fresh 10-year rule. RMDs are due in years 1 – 9 based on Kathy’s single life expectancy, and the estate-owned account must be emptied by the end of year 10.

Answer: Based on whether the IRA owner or plan participant dies before or after the owner’s required beginning date (RBD). The RBD is generally April 1 after the year of the 72nd birthday. SECURE 2.0 Act Update: For those who turn age 72 after 2022, the RBD is April 1 after the year of the 73rd birthday. If owner dies before the RBD, the account must be withdrawn by the end of the 5 th year after death – the 5-year rule. There are no annual RMDs during the 5-year window. If owner dies on or after the RBD, RMDs must be taken over the deceased IRA owner’s (or plan participant’s) remaining single life expectancy – “ghost life rule.” (Note: This can produce a post-death payout exceeding 10 years)

10-year rule is applied to All designated beneficiaries who do not qualify as EDBs (Eligible Designated Beneficiary). Examples: grandchildren, older children, some look-through trusts 

Post-death Payout Rules for NEDBs – depends on whether death occurs before or after the required beginning date (RBD) • If owner dies before the RBD, there are no annual RMDs during the 10-year window. • If owner dies on or after the RBD, annual (stretch IRA) RMDs must be taken for years 1-9. Entire account must be emptied by the end of the 10th year after death – the 10-year rule.

The SECURE Act exempts these beneficiaries from the 10-year rule. However, if the account owner dies before the RBD (Required Beginning Date), an EDB can elect the 10-year rule. EDBs must be designated beneficiaries. 

Here are 5 Classes of Eligible Designated Beneficiaries.

1. Surviving spouses 
2. Minor children of the account owner, until age 21 – but not grandchildren 
3. Disabled individuals – under the strict IRS rules 
4. Chronically ill individuals 
5. Individuals not more than 10 years younger than the IRA owner. (Those older than the IRA owner also qualify.) 

Plus – Any designated beneficiary (including qualifying trusts) who inherited before 2020. These beneficiaries are grandfathered under the pre-2020 stretch IRA rules. In addition, trusts for the sole benefit of these EDBs should qualify as an EDB. EDB status is determined at date of owner’s (or plan participant’s) death and cannot be changed.

Single Life Expectancy Table is used to calculate RMDs for:

• Designated Beneficiaries (DBs) who inherited before 2020. 
• DBs who inherit in 2020 or later when the account owner dies ON OR AFTER his RBD – for years 1-9 of the 10-year period. 
• Eligible Designated Beneficiaries (EDBs).
• Non-Designated Beneficiaries when the account owner dies ON OR AFTER his RBD for “ghost rule” RMDs.

 

This table is not used by:

• DBs who inherit in 2020 or later when the account owner dies BEFORE the RBD.
• IRA owners to calculate lifetime RMDs.
• Roth IRA beneficiaries, who are not EDBs

The SECURE Act, SECURE 2.0 and corresponding IRS proposed regulations have created a bevy of confusion across multiple aspects of retirement accounts. Of all the changes, one stands out as particularly puzzling: the IRS’s continued application of a pre-SECURE Act tax code guideline, the “at least as rapidly” (ALAR) rule. The manner in which the IRS currently applies the ALAR rule in certain situations has confounded advisors and beneficiaries alike. 

 

A Function of Frequency, Not Amount 

For deaths in 2020 or later, the SECURE Act subjects a non-eligible designated beneficiary (NEDB) of an IRA to the 10-year payout rule. This requires the inherited IRA to be emptied by the end of the tenth year after the year of death. In its SECURE Act – Proposed Regulations-REG-105954-20 from February 2022, the IRS took the position that when death occurs on or after the required beginning date (RBD – generally April 1 of the year after a person turns 73), an NEDB must also take annual required minimum distributions (RMDs) in years 1 – 9 of the 10- year period. (Note: Since lifetime RMDs are not required from Roth IRAs, all Roth IRA owners are deemed to have died before their RBD.) 

 

This requirement of annual RMDs within the 10-year period when an account owner dies on or after the RBD stems from the old ALAR rule. While this rule does not require the same amount that was taken by the IRA owner to also be taken by the beneficiary, it does require that the process of taking RMDs continue. This is a key point. ALAR is not a function of amount, it is a function of frequency. 

 

Have RMDs Been “Turned On”? 

An easy way to understand this concept is: if RMDs have been “turned on” (i.e., the owner reached his RBD), they cannot be turned off. If the original IRA owner died before the RBD – he was not yet required to take lifetime RMDs – then there are no RMDs in years 1 – 9 for the NEDB. Why? RMDs were never “turned on.” However, if that same IRA owner died on or after his RBD, that same NEDB would be required to take RMDs in years 1 – 9 of the 10-year period because RMDs had been turned on. (Whatever is left in the account at the end of year 10 is considered the total final RMD.) 

 

Example: Abe, age 80, dies in 2022. The beneficiary of his traditional IRA is his daughter Martha. Martha is an NEDB and must take annual RMDs from the inherited IRA for years 2023 – 2031 (years 1-9 of the 10-year period). Also, the entire remaining inherited IRA balance must be distributed by December 31, 2032. Martha will use the IRS Single Life Expectancy Table to calculate her initial RMD factor. Since she is 56 in 2023, her corresponding factor is 30.6. Martha will subtract 1 from this factor in each successive year. Martha’s RMDs will be less than Abe’s, but this is of no consequence. The ALAR rule simply dictates that RMDs must continue annually.

10 Year Rule, No Matter What 

Successor beneficiaries – the beneficiary of the beneficiary – are bound by the 10- year rule no matter their relationship to the previous account owner or their physical condition. It does not matter if the successor is a spouse, disabled or could otherwise qualify as an eligible designated beneficiary (EDB) and therefore be able to stretch RMD payments. All successor beneficiaries must follow these rules: 

 

• If the original beneficiary was using the 10-year rule, the successor can only continue whatever time remains on that existing 10-year period. A new 10-year period cannot be tacked on. 

 

• If the original beneficiary was stretching inherited account payments over his own single life expectancy, the successor will continue that same payment structure, using the exact same single life expectancy factor, but will also overlay the 10-year rule. 

 

If RMDs were “turned on” at any point prior to the successor beneficiary acquiring the account, those RMDs cannot be turned off.  

 

Traditional IRA, RMDs Turned On by First Beneficiary 

Example: Florence, age 55, dies in 2020. She named her son Gary, age 30, as beneficiary of her traditional IRA. On that date, Gary qualifies as a chronically ill EDB (Eligible Designated Beneficiary) under the tax code definition, so he can begin taking stretch RMDs based on his own single life expectancy. Gary dies in 2028 with his son, Jay, as primary beneficiary. Jay is the successor beneficiary and must receive the remaining IRA portion by the end of the 10th year following his father’s death (December 31, 2038). Since Gary “turned RMDs on” as an EDB, the ALAR rule dictates that Jay cannot turn RMDs off. He must take RMDs for years 1-9 within the 10-year period based on Gary’s RMD schedule. It does not matter that Florence (the original IRA owner) had not yet started taking RMDs at her death.

 

Roth IRA, No RMDs 

Example: Bernice, age 75, dies in 2020. Her Roth IRA beneficiary is her adult daughter, Lisa. Lisa is an NEDB and is subject to the 10-year rule. Since Roth IRA owners are deemed to die before their RBD, Lisa has no RMDs within the 10-year period. Lisa names her son Cliff as successor beneficiary. Lisa dies in 2023. Cliff must empty the inherited Roth IRA by December 31, 2030, which is the end of Lisa’s original 10-year term. The successor cannot tack on a new 10-year term of her own. Cliff continues the remaining years of the original 10-year term – which in this example is 7 more years since Lisa died 3 years into the 10-year term. No annual RMDs are required to be taken in years 1-9 by either Lisa or Cliff. 

 

Roth IRA, RMDs Turned On by First Beneficiary. (Same Scenario, Except Lisa is an EDB) 

Example: Bernice, age 75, dies in 2020. Her Roth IRA beneficiary is her adult daughter, Lisa. Lisa is considered chronically ill and qualifies as an EDB. Lisa chooses to stretch RMD payments over her own single life expectancy. (Lisa is 45 in 2021 and uses a factor of 41.0.) Lisa names her son Cliff as successor beneficiary. Lisa dies in 2023. Cliff is subject to the 10-year rule and must empty the inherited Roth IRA by December 31, 2033. Cliff also must continue the same RMD schedule as Lisa, using Lisa’s same factor.

When does the 5-year rule apply? The only time we see the 5-year payout rule is when a person has a non-designated beneficiary (NDB – like an estate or charity) and the owner dies before the required beginning date. (If they die after the RBD, we have the ghost rule – RMDs based on the single life expectancy of the deceased individual had he lived.) 

If the original IRA owner dies before the RBD, lifetime RMDs are never “turned on.” Since RMDs were never turned on, they do not apply within the 5-year period. 

5-Year Rule vs. 10-Year Rule 

The IRS’s application of the ALAR rule within the 10-year period in the proposed SECURE Act regulations was surprising and controversial. Why? The preSECURE Act 5-year payout rule does not require annual RMDs within the 5- year period. When the SECURE Act substituted “10 years” for “5 years” to create the new 10-year payout rule, industry consensus was there would also be no RMDs in the 10-year period. However, by overlaying the ALAR rule on the new 10-year rule, the IRS concluded that RMDs do apply in some situations within the 10-year period.

The annual RMD requirement within the 10-year period was completely unexpected and did not come to fruition until early 2022. As such, the IRS, in Notice 2022-53, found it necessary to waive penalties for “missed” 2021 and 2022 RMDs for beneficiaries subject to the 10-year rule.

 

What did IRS Notice 2022-53 do?

Notice 2022-53, issued October 7, 2022, waives the 50% penalty (subsequently reduced to 25%, and further to 10% if timely corrected) on missed 2021 and 2022 inherited retirement account RMDs within the 10-year payout rule only. The Notice states the IRS will not impose the penalty for missed 2021 or 2022 RMDs within the 10 years if the account owner died in 2020 on or after the required beginning date (RBD) with a non-eligible designated beneficiary. It will also not impose the penalty for a missed 2022 RMD within the 10 years if the account owner died in 2021 on or after the RBD.

 

What was the reason for the guidance? 

After issuing proposed regulations in February of 2022, the IRS received numerous comments that applying the annual RMD requirement for 2021 would be unfair since no one thought RMDs were required within the 10-year period. The public was also confused about 2022 RMDs. 

 

Is Notice 2022-53 applicable to successor beneficiaries? 

Yes, the penalty waiver also applies to certain successor beneficiaries – i.e., beneficiaries of eligible designated beneficiaries (EDBs) – who died in 2020 or 2021 while taking annual RMDs. 

 

What if I already paid the penalty? 

If a beneficiary paid the 50% penalty for a missed 2021 RMD within the 10-year rule, the beneficiary can request a refund from the IRS. 

 

Do I still need to take the RMD from my inherited account, or was it waived? 

Although the Notice is not clear, it appears that since the penalty is waived, the 2021 and 2022 RMDs within the 10-year period do not have to be taken. 

 

If I already took my RMD within the 10-year period, can I put it back? 

No. If a 2021 or 2022 RMD within the 10-year period was taken, it cannot be returned or rolled over. 

 

Which accounts are NOT affected? 

• IRAs and company plan accounts that are paying lifetime RMDs.
• IRAs and company plan accounts inherited by EDBs who are stretching RMD payments. 
• IRAs and company plan accounts inherited prior to the SECURE Act (i.e., grandfathered stretch payments). 
• Certain inherited Roth IRAs. (Roth IRA owners are deemed to die before their RBD, so no RMDs ever apply in years 1–9 of the 10-year period.) 

 

Will the IRS scrap the annual RMD requirement within the 10-year rule entirely? 

The IRS did not provide any indication in Notice 2022-53 whether it would ultimately change its mind about annual RMDs for years 1-9 of the 10-year period. Many commentators are hoping the IRS will reconsider the annual RMD requirement within the 10-year period when final SECURE 2.0 regulations are issued. However, in SECURE 2.0, Congress had the opportunity to delete the ALAR rule from the tax code, an amendment that would have done away with the annual RMD rule, but they did not. The fact that Congress failed to do so likely means the IRS will stick to its original positioning. In any case, until final regulations are released – which could be years in the making – it is advisable for beneficiaries to follow the guidance from the proposed regulations.

While the tax code bounces a reader from section to section, the IRS does seem to have justification for requiring annual RMDs in ALAR situations. Page 44 of the “Explanation of Provisions” of the proposed regulations reads as follows: 

 

“Accordingly, if an employee dies after the required beginning date, distributions to the employee’s beneficiary for calendar years after the calendar year in which the employee died must satisfy section 401(a)(9)(B)(i) as well as section 401(a)(9)(B)(ii).” 

 

Translation: Both the ALAR rule and the 10-year rule apply for an NEDB when death is on or after the RBD. As directed by the “Explanation of Provisions” above, we must now dig into the language of section 401(a)(9) of the code: 

 

(9) REQUIRED DISTRIBUTIONS. 

(A) In general. A trust shall not constitute a qualified trust under this subsection unless the plan provides that the entire interest of each employee:

 (i) will be distributed to such employee not later than the required beginning date, or 

(ii) will be distributed, beginning not later than the required beginning date, in accordance with regulations, over the life of such employee or over the lives of such employee and a designated beneficiary (or over a period not extending beyond the life expectancy of such employee or the life expectancy of such employee and a designated beneficiary). 

 

(B) Required distribution where employee dies before entire interest is distributed. 

(i) Where distributions have begun under subparagraph (A)(ii). A trust shall not constitute a qualified trust under this section unless the plan provides that if: 

(I) the distribution of the employee’s interest has begun in accordance with subparagraph (A)(ii), and 

(II) the employee dies before his entire interest has been distributed to him, the remaining portion of such interest will be distributed at least as rapidly as under the method of distributions being used under subparagraph (A)(ii) as of the date of his death. 

(ii) 5-year rule for other cases. 

A trust shall not constitute a qualified trust under this section unless the plan provides that, if an employee dies before the distribution of the employee’s interest has begun in accordance with subparagraph (A)(ii), the entire interest of the employee will be distributed within 5 years after the death of such employee. 

 

5-Year/10-Year Language Substitution 

While the above references a 5-year payment rule, section 401(a)(9)(H) substitutes a “10-year rule” for all NEDBs regardless of whether the IRA owner died before or after his required beginning date. 

 

(H) Special rules for certain defined contribution plans. In the case of a defined contribution plan, if an employee dies before the distribution of the employee’s entire interest: 

(i) In general. Except in the case of a beneficiary who is not a designated beneficiary, subparagraph (B)(ii): 

(I) shall be applied by substituting “10 years” for “5 years,” and 

(II) shall apply whether or not distributions of the employee’s interests have begun in accordance with subparagraph (A).  

 

Guidance is Needed! 

This question was received by the Slott Report Mailbag and answered in the June 22, 2023 Slott Report: 

 

Question: 

Hello, I am involved with a traditional non-spouse inherited IRA that was passed from my mother to myself and two siblings in 2022. My mother was 84 when she died and was taking RMDs. I understand the new legislation passed under the SECURE Act requires any such traditional inherited IRA requires full distribution by the end of the 10-year period following her death. I fully understand the law change.

 

My question revolves around potential yearly RMDs for each of us starting in 2023. Are RMDs for inherited IRAs now required by IRS regulation starting in 2023? If so, under what table is the RMD calculated (by applying the factor to the 12/31/2022 balance)? 

 

The Treasury issued PROPOSED regulations in 2022 indicating that RMDs for inherited IRAs would be required. My understanding is the proposed regulations were met with significant protest by tax professionals and practitioners. However, my understanding is that PROPOSED regulations are not binding until finalized by the Treasury Dept. I have not seen any document or commentary indicating that the applicable regulations have ever been finalized. Are RMDs required for inherited IRAs in 2023 until the Treasury Dept. finalizes the regulations? 

 

Thank you. 

 

Mike 

 

Answer: 

 

Hi Mike, 

 

We believe that annual RMDs are required for 2023. As you noted, the IRS issued proposed regulations in February 2022 requiring that beneficiaries subject to the 10-year payout rule also take annual RMDs in years 1-9 of the 10-year period. That annual RMD requirement applies only if the IRA owner died on or after his RMD required beginning date. While those proposed regulations have not yet been finalized, the prudent course would be to follow the proposed regulations until the IRS finalizes the rules – which could take some time. Since your mother died after her required beginning date, you and your siblings must take the first annual RMD by 12/31/23. If the IRA has already been split into separate inherited accounts, or will be split by 12/31/23, you and your siblings would each use your respective life expectancy factor under the IRS Single Life Expectancy Table for 2023. For subsequent years, you and your siblings would subtract one from the prior year’s factor.