In 2019, the SECURE Act changed how inherited RMD rules work and added a new 10-Year Rule. While most professionals thought they knew how the new 10-Year Rule worked, now after many IRS notices, we aren’t sure how the new rules work.
Fortunately, in a recent October 2022 notice, the IRS guided that they will waive penalties for failing to take a 2021 or 2022 inherited RMD for those who are caught in the limbo of this decision. They also noted that whatever the new rules are won’t take affect until 2023 at the earliest.
That’s the summary. If you are interested in a more thorough description of the issue, read on.
How We Thought It Worked
After the SECURE Act, the new U.S. Code 401(a)(9)(H)(i)(I) states:
(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).
(ii) Exception for eligible designated beneficiaries.—
Subparagraph (B)(iii) shall apply only in the case of an eligible designated beneficiary.
This change effectively replaces the old 5-Year Rule with a new 10-Year Rule for designated beneficiaries only and also gives stretch provisions (the old way inherited RMDs usually worked which is described in B.iii) to only the newly created class of beneficiaries called “eligible designated beneficiaries.”
The old 5-Year Rule it was replacing has previously required that heirs distribute 100% of the account by December 31 of the year of death plus five but has not required annual distributions. IRS Publication 590B has summarized this as:
The 5-year rule requires the IRA beneficiaries who are not taking life expectancy payments to withdraw the entire balance of the IRA by December 31 of the year containing the fifth anniversary of the owner’s death. For example, if the owner died in 2021, the beneficiary would have to fully distribute the IRA by December 31, 2026. The beneficiary is allowed, but not required, to take distributions prior to that date. The 5-year rule never applies if the owner died on or after his or her required beginning date.
The 5-year rule generally applies to all beneficiaries if the owner died before 2020. It also applies to beneficiaries who are not individuals (such as a trust) if the owner died after 2019. If the owner died after 2019 and the beneficiary is an individual, see 10-year rule next.
After the SECURE Act created the new 10-Year Rule, IRS Publication 590B was updated to read:
The 10-year rule requires the IRA beneficiaries who are not taking life expectancy payments to withdraw the entire balance of the IRA by December 31 of the year containing the 10th anniversary of the owner’s death. For example, if the owner died in 2021, the beneficiary would have to fully distribute the IRA by December 31, 2031. The beneficiary is allowed, but not required, to take distributions prior to that date.
The 10-year rule applies if (1) the beneficiary is an eligible designated beneficiary who elects the 10-year rule, if the owner died before reaching his or her required beginning date; or (2) the beneficiary is a designated beneficiary who is not an eligible designated beneficiary, regardless of whether the owner died before reaching his or her required beginning date.
For a beneficiary receiving life expectancy payments who is either an eligible designated beneficiary or a minor child, the 10-year rule also applies to the remaining amounts in the IRA upon the death of the eligible designated beneficiary or upon the minor child beneficiary reaching the age of majority, but in either of those cases, the 10-year period ends on December 31st of the 10th anniversary of the eligible designated beneficiary’s death or the child’s attainment of majority.
In other words, the 10-Year Rule was the same as the 5-Year Rule except that it was 10 years instead of 5 years. Since that IRS publication update, we’ve learned that the lawyers at the IRS disagreed with that implementation.
How the IRS Thought It Worked
In February 2022, the IRS released proposed regulations for how to integrate the new inherited RMD rules from the SECURE Act into law. Those proposed regulations were a shock to everyone, including us, most tax professionals, and even the author of the original IRS Publication update. In the proposed regulations, the IRS writes:
While the 5-year rule under section 401(a)(9)(B)(ii) (expanded to a 10-year rule in certain cases by section 401(a)(9)(H)(i)(I)) generally applies if an employee dies before the employee’s required beginning date, section 401(a)(9)(H)(i)(II) provides that section 401(a)(9)(B)(ii) applies whether or not distributions have commenced. 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). In order to satisfy both of these requirements, these proposed regulations provide for the same calculation of the annual required minimum distribution that was adopted in the existing regulations but with an additional requirement that a full distribution of the employee’s entire interest in the plan be made upon the occurrence of certain designated events (discussed in section I.E.3.c. of this Explanation of Provisions).
What they are saying here is U.S. Code 401(a)(9)(B)(i) requires that the inherited portion of a retirement plan be distributed “at least as rapidly as” the original owner’s distributions if those distributions have started or, in (B)(iii), according to the 5-Year Rule. However, because the new 10-Year Rule text says that it applies “whether or not distributions of the employee’s interests have begun,” the question is how can we apply the 10-Year Rule (presumably distribute 100% by the end of year 10 without regard to annual RMDs) and the requirement that the distributions occur “at least as rapidly as” the original owner’s distributions.
To reconcile those two seemingly contradictory items in the U.S. Code, the IRS proposed the requirement of annual RMDs under the 10-Year Rule. They proposed that if an IRA was inherited after the original owner’s Required Beginning Date (they had already been required to start taking RMDs), then those RMDs must continue beyond the original owner’s passing. This suggests that in years 1-9 inherited IRA holders must take at least the previous owner’s RMD, with the entire account needing to be depleted in year 10.
This created a bit of panic. The penalty for failing to take an RMD is a steep 50% tax, and the SECURE Act came into effect for inherited IRAs from deaths in 2020 or later. While the 2020 RMD was waived due to the CARES Act, this left account holders unsure if they missed Required Minimum Distributions from 2021 and thus owed hefty penalties. Additionally, the 2022 inherited distribution requirements must happen before December 31, 2022, but we still don’t know what those requirements are. This IRS document is just proposed guidance, not yet actual guidance.
As such, we’ve been waiting, watching, and hoping the IRS would issue more guidance on the matter before it was too late.
No RMD Penalty for Failing to Take a 2021 and 2022 10-Year-Rule Inherited RMD
Fortunately, on October 7, 2022 the IRS issued Notice 2022-53 , which announced that the IRS would not be issuing tax penalties for missed 2021 and 2022 RMDs from Inherited IRAs subject to the 10-Year Rule. They also announced that they expect to have final guidance which will apply no earlier than 2023. The notice reads:
III. Applicability Date of Final Regulations
Final regulations regarding RMDs under section 401(a)(9) of the Code and related provisions will apply no earlier than the 2023 distribution calendar year.
1.Guidance for Certain RMDs for 2021 and 2022
A. Guidance for defined contribution plans that did not make a specified RMD
A defined contribution plan that failed to make a specified RMD (as defined in Section IV.C of this notice) will not be treated as having failed to satisfy section 401(a)(9) merely because it did not make that distribution
B. Guidance for certain taxpayers who did not take a specified RMD
To the extent a taxpayer did not take a specified RMD (as defined in Section IV.C of this notice), the IRS will not assert that an excise tax is due under section 4974. If a taxpayer has already paid an excise tax for a missed RMD in 2021 that constitutes a specified RMD, that taxpayer may request a refund of that excise tax.
While the decision not to penalize those who failed to take distributions in 2021 and 2022 was well received, the rest of the notice lacked clarity. We still are left wondering what will be decided, when it will be decided, and what we should do for 2023 onward.
While we won’t know with any certainty until the IRS publishes their final guidance, it is likely that Inherited IRA owners will be required to take distributions if they inherited their accounts from an original owner who had already started RMDs and died in or after the year 2020.
Those who have inherited Roth IRAs should wait for the final guidance to verify whether or not annual inherited distributions are required.
Those who have inherited Traditional IRAs may benefit from voluntary withdrawals regardless of whether annual distributions are required. Taking withdrawals gradually over the 10-year period can keep you in lower tax brackets overall and avoid a sudden and large tax hit from a 100% distribution in year 10.
We will continue to monitor the IRS guidance on this matter. If you’d like to stay updated on our latest understanding of this issue, you may enjoy subscribing to our newsletter.
It is important to note that we are not tax professionals. As always, if you have any tax questions, the best advice is to consult with your tax professional.
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