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New IRS SECURE Act Regulations and Missed RMDs

Question:
I read your 2/28/22 Slott Report on the updated SECURE Act information for non-eligible designated beneficiaries (non-EDBs) that requires annual RMDs to continue if the original owner was taking them prior to his death and also requires the account to be emptied by the end of year 10.

Since the Roth IRA does not have RMDs, is it correct to assume that the non-EDB of an inherited Roth IRA would also not be required to take RMDs and only be subjected to the 10-year rule?

Answer:
You are correct. The new IRS regulations specifically say that Roth IRA owners are considered to have died before their RMD required beginning date (RBD). Since the new annual RMD requirement applies only when an IRA owner dies on or after his RBD, beneficiaries of inherited Roth IRAs are spared from this rule. However, those beneficiaries still have to empty the account by December 31 of the 10th year following death.

Question:
I do taxes for an 80+ year old lady with an IRA. She said she never received a letter from the company she has her IRA with to let her know she needed to take a withdrawal for 2021. The company, of course, says they did.

I am trying to find a way to rectify this situation. She is filling out the paperwork for the 2021 RMD, but because she is two months past the due date, technically she owes the penalty. Should we file her taxes for 2021 and just wait for the IRS to catch up with this?

Answer:
There is a 50% excise tax for missing an RMD. However, the IRS will usually waive that penalty if the IRA owner takes the RMD and files Form 5329 with the IRS. The Form 5329 should include an attachment explaining why your client did not take the 2021 RMD. She does not need to pay the excise tax unless the IRS comes back and assesses it (which is unlikely).

Required Minimum Distributions and Inherited IRAs

Question:
Hello. I was reading the 2/28/22 edition of the Slott Report and noticed the section titled “Beneficiaries Hit w/Annual RMDs and the 10-Year Rule.” It was my understanding that starting 1/1/20, most non-spouse beneficiaries would have 10 years from the year of death to distribute the IRA, with no RMDs required.

Will adult individuals who inherit a traditional IRA from an 80-year-old parent in 2020, for example, now have to start taking annual RMDs, with the remaining balance withdrawn in the 10th year?

Answer:
This is a great question. The IRS just recently released proposed SECURE Act regulations. In the regulations, they do take the position that, if the IRA owner died on or after his required beginning date, then annual RMDs would be required, as well as the SECURE Act’s 10-year rule. In your example, an adult child, who inherits a traditional IRA from a parent who dies at age 80, would need to take annual RMDs from the inherited IRA (for years 1-9 after the year of death) and also empty the account by the tenth year following the year of death. If the IRA owner dies before his required beginning date, then no annual RMDs would be required during the 10-year payout period.

Question:
If a Roth IRA was inherited before 2019 and the non-spouse beneficiary is taking RMDs under the old stretch lifetime rules, will the new changes to the IRS life expectancy table apply to that inherited Roth IRA staring in 2022?

And, if yes, will the IRA custodian automatically make the changes (apply the new factors), or does the beneficiary have to do something?

Answer:
All beneficiaries who are required to take annual RMDs from inherited IRA can use the new life expectancy tables issued by the IRS starting for 2022 RMDs. For a non-spouse beneficiary, this may mean resetting her factor by finding her age in the year following the Roth IRA owner’s death on the new table and then subtracting one for each year that has passed through 2022. Custodians are likely to make the changes automatically, but if you have any questions you should contact them or reach out to a knowledgeable tax or financial advisor.

SECURE Act Regs Bring New Roth IRA Advantage

Roth IRAs have always been a great retirement savings tool. While pre-tax retirement accounts allow tax deferred savings, a Roth IRA promises tax-free benefits. They allow you to receive years of earnings in retirement without tax consequences. Those tax-free distributions also have the side benefit of not increasing stealth taxes such as IRMAA surcharges and taxation of Social Security benefits. Add in the fact that a Roth IRA does not require RMDs during the owner’s lifetime (unlike qualified plans and traditional IRAs), and it is easy to see the Roth advantage. The newly released SECURE Act regulations have added another benefit to the Roth IRA tax break list with their unexpected interpretation of the 10-year payment rule.

In the new regulations, the IRS has taken the position that when an IRA owner dies on or after their required beginning date and the 10-year rule applies, the account is also subject to annual RMDs. This surprising interpretation of the SECURE Act will affect a lot of IRA beneficiaries because most IRA beneficiaries will be subject to the 10-year rule under the SECURE Act and many IRA owners die when they are older and beyond their required beginning date. Now these beneficiaries are subject to the hassle of having to calculate annual RMDs during years one to nine of the 10-year period using tricky rules. They must take taxable distributions to avoid a hefty 50% penalty for missed RMDs.

Good news for Roth IRA beneficiaries! The IRS confirms in the regulations that all Roth IRA owners are considered to have died before their required beginning date. This means no annual RMDs from inherited Roth IRAs are required for beneficiaries subject to the 10-year rule. An inherited Roth IRA offers complete flexibility within the 10-year period and completely avoids the complicated RMD rules. And, best of all, the Roth IRA can grow tax-free for ten years before any distributions are required.

Example: Rodney, age 75, dies in 2022. The beneficiary of his Roth IRA is his daughter, Rhianna, age 50. Rhianna will be subject to the 10-year rule, but she does not have to take annual RMDs. She can let the Roth IRA grow and accumulate tax-free earnings for ten years. The entire inherited Roth IRA must still be distributed by December 31, 2032, but it will be a tax-free distribution.

The Most Controversial Part of the New IRS Regulations

The part of the new IRS SECURE Act regulations causing the most reaction is the one requiring annual required minimum distributions (RMDs) for some IRA or workplace plan beneficiaries subject to the 10-year payment rule.

Under the SECURE Act, IRA or plan beneficiaries who are not “eligible designated beneficiaries” (EDBs) are subject to the 10-year rule. (EDBs are surviving spouses; children of the IRA owner or plan participant who are under age 21; disabled or chronically ill individuals; and anyone not more than 10 years younger than the owner/participant.) Non-EDBs must empty the IRA or plan account by the end of the 10th year following the year the owner or participant died. On the other hand, EDBs are allowed to stretch required minimum distributions (RMDs) over their life expectancy.

Prior to the issuance of the new regulations, most commentators believed the 10-year rule never required annual RMDs for years 1-9 of the 10-year period. In the past, the IRS has given out mixed signals on this issue. However, in the new regulations, the IRS very clearly says that certain non-EDBs are subject to both the 10-year payment rule and a requirement to take annual RMDs in years 1-9 of that 10-year period.

Only non-EDBs who inherit on or after the owner or participant’s required beginning date (RBD) are subject to the annual RMD requirement. Non-EDBs who inherit before the decedent’s RBD can take as little or as much as they want over the 10-year period. But the rule requiring distribution of the entire account by the end of the 10-year period still applies.

So, what is the RBD? It’s the date by which the first RMD is due. For an IRA owner born before July 1, 1949, it’s April 1 of the year following the year she turned age 70 ½. For an IRA owner born on or after July 1, 1949, it’s April 1 of the year following the year she turns 72. For plan participants who don’t own more than 5% of the company sponsoring the plan, the RBD can be delayed until April 1 of the year following the year of retirement.

What if you are a non-EDB who inherited in 2020 after the owner/participant’s RBD and you didn’t receive your 2021 RMD (because you didn’t know it was required)? Should you take the missed RMD now? Keep in mind it’s possible that 2021 annual RMDs in this situation were not required based on the fact the new regulations technically weren’t effective last year. (This is a murky legal question.) It’s also possible the IRS will issue relief for missed 2021 RMDs later this year. Holding off taking your 10-year-rule 2021 RMD until later in 2022 won’t subject you to any higher penalty than if you take it now. So, if you are in the affected category of non-EDBs, you may want to delay your “missed” 2021 RMD until later in 2022 when we may know more. Talk this over with a knowledgeable financial advisor.

Meanwhile, we’ll let you know about any further guidance from the IRS on this issue.

Age of Majority and the New SECURE Act Regulations

The 275 pages of proposed SECURE Act regulations, released by the IRS on February 23, are chock full of little details. Each of these tidbits will have some impact on particular IRA owners and retirement account participants.

One such new rule pertains to the age of majority. When is a minor child recognized as an adult? Existing IRS guidance deferred to the age of majority under state law. This created some confusion as most states said age 18, a couple said 19, and Mississippi said 21. Why is this important? The age of majority dovetails with the opportunity a minor beneficiary has to stretch inherited IRA account assets.

The new regulations draw a universal line in the sand. The age of majority is now recognized as 21.

The minor child of an IRA account owner is considered an eligible designated beneficiary (EDB). As an EDB, that minor child is allowed to use her own single life expectancy to calculate an annual required minimum distribution (RMD). This will allow the child to stretch IRA payments until she is 21. At that time, the 10-year payout rule will apply, and the now-adult child will have another 10 years to maintain the inherited IRA. (Future Slott Report entries will discuss the new guidelines governing the 10-year rule.)

Example: Meredith dies at age 48. She had an IRA, and her only daughter Sally, age 10, was listed as the beneficiary. Sally is an EDB, so she is permitted to stretch IRA payments over her own life expectancy. (When RMDs start in the year after death, when Sally is 11, she will use the single life expectancy factor of 73.9.) Sally can take annual RMD payments until she is 21. At that point, the 10-year rule will apply. Sally must then empty the account by December 31 of the tenth year following the year she turns 21.

Additionally, the new SECURE Act regulations changed a provision which allowed minor children who were still in school to extend the age of majority to as late as age 26. This is no longer an option and, as such, should minimize confusion. The “still-in-school” language is no more. The age of majority, as recognized by the SECURE Act regulations, is fixed at 21.

Stay tuned for more summaries of the SECURE Act regulations in the coming days and weeks. There is lot to dig through in those 275 pages, and we will do our best to bring you the pertinent highlights…and lowlights.

SECURE Act Regulations Are Here

On February 23, 2022, the IRS released the long-awaited proposed SECURE Act regulations. The new regulations clock in at 275 pages and offer guidance on many SECURE Act rules. They also include a few surprises. Here are some highlights.

Eligible Designated Beneficiaries

The SECURE Act did away with the stretch IRA for most beneficiaries, but those who are considered an eligible designated beneficiary (EDB) can still take advantage of it. The regulations clarify exactly who is an EDB. They specify that a minor child of an IRA owner is considered an EDB until his 21st birthday. The regulations also provide guidance on determining who qualifies as disabled, particularly for beneficiaries under age 18.  Also, a new documentation requirement is imposed on chronically ill and disabled EDBs to qualify for the stretch.

Trusts

The SECURE Act upended the rules for trusts as beneficiaries of IRAs, and guidance addressing the outstanding issues were sorely needed. The newly released regulations keep many of the rules that existed for trust beneficiaries prior to the SECURE Act such as the rules for look-through trusts. If a trust satisfies the look-through rules, then the beneficiaries of the trust are considered designated beneficiaries.

The regulations also attempt to answer some of the many issues with trusts that were raised in private letter rulings over the years. This includes when beneficiaries can be disregarded for purposes of identifying RMD payments, the impact of powers of appointments, and state laws that permit the terms of a trust to be modified after death.

The SECURE Act carved out special rules for trusts with disabled or chronically ill individuals allowing the stretch even if the trust has other beneficiaries. The new regulations provide guidance on these trusts and also add minor children of the IRA owner as another category of EDB that can still qualify for the stretch even if there are other non-EDB trust beneficiaries.

Beneficiaries Hit with Annual RMDs and the 10-Year Rule

The IRS has taken a somewhat surprising position on the new 10-year rule imposed by the SECURE Act. If the account owner dies before her required beginning date, the 10-year rule only requires that the entire account be emptied by December 31 of the tenth year following the year of death. There are no annual RMDs. However, the new regulations say that if the IRA owner dies after her required beginning date, then not only does the 10-year rule apply, but also annual RMDs are required in years one through nine.

Spousal Rollovers

The regulations include a new rule for spousal rollovers that seems to be intended to prevent spouse beneficiaries from using the new 10-year rule to delay RMDs. The rule requires “hypothetical missed RMDs” to be taken when a spousal rollover is done in some circumstances.

50% Penalty Relief

If the IRA owner was required to take an RMD in the year of their death, the rules require the beneficiary to take that RMD if the IRA owner did not do so prior to death. This rule can be hard on beneficiaries when the IRA owner dies late in the year. The new regulations provide some relief in these situations by providing an automatic waiver of the 50% penalty that usually applies when an RMD is missed. This waiver is available as long as the beneficiary takes the year of death RMD by her tax-filing deadline, including extensions.

Stay Tuned

The new regulations are proposed to apply for determining RMDs for 2022 and later. Public comments are being accepted and a hearing is scheduled in Washington for June 15, 2022. The IRS will then issue final regulations at some point in the future. That could take some time. Stay tuned to the Slott Report for more information on the new SECURE Act regulations!