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Last week, the Internal Revenue Service issued the long-awaited final regulations on Required Minimum Distributions (RMDs) from retirement accounts. These regulations clarify key portions of the SECURE Act of 2019 and the SECURE 2.0 Act of 2022, which sometimes felt like a moving target.
This blog post is a reference guide for you on the new IRS regulations and clarifications regarding RMDs from retirement accounts. After all the confusion since the initial SECURE Act, we hope this information will help you plan with your clients and be a resource to prospects you are converting to clients.
New RMD Required Beginning Dates:
There is not much new here that you do not already know. In 2024, the start age moved from 72 to 73 and for clients born in 1960 or later, the RMD start age will be 75. The fun fact is that in 1960, Coca-Cola introduced Sprite to the market.
In summary:
1. Born before 7/1/1949: Age 70½
2. Born 7/1/1949 to 12/31/1950: Age 72
3. Born 1951-1958: Age 73
4. Born 1960 or later: Age 75
*NOTE: Where's 1959? An issue related to the SECURE 2.0 Act concerns the RMD start age for those born in 1959. Footnote 7 in the final regulation notes, “Section 107 of the SECURE 2.0 Act includes an ambiguity relating to the definition of applicable age for employees born in 1959 (section 401(a)(9)(C)(v) provides that the applicable age for those employees is both 73 and 75).”
A separate notice of proposed rulemaking (REG-103529-23) released today states, “the applicable age for an employee who was born in 1959 would be age 73.” A public hearing on this proposed rulemaking is set for Sept. 25, 2024.
10-Year Rule Clarification:
There has been quite a bit of confusion regarding the 10-year rule for RMDs from inherited IRAs. Initially, we all believed that the 10-year rule would mirror the 5-year rule, with no annual RMDs required for the beneficiary. The IRS then issued conflicting guidance, stating that annual RMDs were required if the original IRA owner had begun taking RMDs and reversing this position, only to reaffirm it later.
The current regulations now provide clarity on this issue:
1. For non-eligible designated beneficiaries, if the original IRA owner had begun taking RMDs before their death, meaning they had reached their Required Beginning Date, the beneficiary must take annual RMDs in years 1 through 9. The remaining account balance must be distributed by the end of year 10.
2. If the original IRA owner had not yet reached their Required Beginning Date and had not begun taking RMDs, the beneficiary is not required to take annual RMDs in years 1 through 9. However, the entire account balance must still be distributed by the end of year 10.
It is important to note that for accounts where the beneficiary inherited the IRA after the original owner's Required Beginning Date, the IRS has waived the RMD requirements for 2021, 2022, 2023, and 2024. Please remember that these RMD rules do not apply to beneficiaries who inherited their IRA before 2020.
Eligible Designated Beneficiaries (EDBs):
Let us begin by defining who is an eligible designated beneficiary who can still stretch distributions over their life expectancy:
1. Surviving spouses
2. Minor children of the IRA owner until reaching the age of majority
3. Disabled individuals
4. Chronically ill individuals
5. Individuals not more than ten years younger than the IRA owner
The new regulation clarifies some key points:
1. Age of Majority is defined as 21 for purposes of the EDB rules, regardless of state law definitions.
2. Spouse as EDB regulations reflect changes made by the SECURE 2.0 Act, which allows a surviving spouse to elect to be treated as an employee for specific purposes.
3. If an EDB dies while taking life expectancy distributions, the remaining account balance must be distributed within ten years of the EDB's death.
4. Special rules apply when there are multiple beneficiaries, some of whom are EDBs and others who are not.
5. The regulations guide how trusts with EDBs as beneficiaries are treated, including specific rules for applicable multi-beneficiary trusts.
6. The new regulations provide specific definitions for "disabled" and "chronically ill" status, which are crucial for determining Eligible Designated Beneficiary (EDB) status. For adults, the definition of "disabled" follows section 72(m)(7) of the Internal Revenue Code, which defines an individual as disabled if they are unable to engage in any substantial gainful activity due to a medically determinable physical or mental impairment that is expected to result in death or be of long-continued and indefinite duration.
7. The "chronically ill" definition aligns with section 7702B(c)(2) of the Code, generally requiring that the individual be unable to perform at least two activities of daily living without substantial assistance from another individual for at least 90 days or require substantial supervision to protect them from threats to health and safety due to severe cognitive impairment.
8. For individuals under age 18, the regulations introduce a special definition of disability: An individual under 18 is considered disabled if they have a medically determinable physical or mental impairment that:
a) Results in marked and severe functional limitations
b) Is expected to result in death or
c) Has lasted or is expected to last for at least 12 continuous months.
This definition aligns with the Supplemental Security Income (SSI) program criteria and focuses on functional limitations rather than workability. The impairment must be severe, and the condition must be either terminal or long-term.
Important considerations:
a) The disability status is determined by the plan owner's death date.
b) Upon reaching age 18, the standard definition of disability under section 72(m)(7) applies.
c) This special definition ensures severely impaired minors can qualify as EDBs.
d) For both disabled and chronically ill beneficiaries, documentation of their status must be submitted to the plan administrator by October 31 of the year following the plan owner's death.
These provisions offer more detailed guidance on identifying and treating EDBs, which is important for proper estate and retirement planning. The rules seek to provide continued favorable treatment for these specific beneficiary categories while implementing the overall intent of the SECURE Act to limit stretch IRA strategies.
Trust Beneficiaries:
The regulations update "see-through" trust rules, which are crucial for estate planning. They clarify when trust beneficiaries are treated as direct beneficiaries of the retirement account owner. It is advisable to review current trusts to ensure compliance with these regulations.
Roth Accounts in Employer Plans:
Lifetime RMDs are eliminated for designated Roth accounts in employer plans, effective for tax years beginning after 12/31/2023. This change may make Roth conversions or contributions in employer plans more attractive to some clients.
Qualifying Longevity Annuity Contracts (QLACs):
These changes in the new regulations might make QLACs a more viable planning tool for addressing longevity risk in retirement plans.
1. Premium limit increased to $200,000 (adjusted for inflation)
2. 25% of the account balance limit eliminated
3. 90-day free look period allowed
- New rules for divorce situations
Excise Tax on Missed RMDs:
Financial advisors should always emphasize the importance of taking RMDs on time despite the new, more lenient correction options. The new more Lenient Correction Options include:
1. The excise tax for missed RMDs has been reduced from 50% to 25% of the shortfall amount. This represents a significant reduction in the penalty for non-compliance.
2. If the missed RMD is corrected promptly, the excise tax can be further reduced to 10%. This provides a strong incentive for prompt correction of errors.
3. The regulations define a "correction window" during which the reduced 10% penalty rate applies. This window ends on the earliest of
a. The date a notice of deficiency for the excise tax is mailed
b. The date the excise tax is assessed
c. The last day of the second taxable year after the taxable year in which the excise tax is imposed
4. The new rules allow for self-correction of missed RMDs, potentially avoiding the need for a formal submission to the IRS in many cases.
5. The excise tax is automatically waived for missed RMDs in the year of death, provided the beneficiary takes the required distribution by their tax filing deadline (including extensions) for the year following the account owner's death.
6. The IRS has provided relief for missed RMDs for particular beneficiaries for 2021-2024, acknowledging the confusion caused by changing regulations.
Transition When an EDB Passes Inherited IRAs to Non-EDBs:
The regulations provide clear guidance on the treatment of retirement accounts when an Eligible Designated Beneficiary (EDB) dies, and the account passes to a non-EDB heir. Initially, an EDB is allowed to take distributions over their life expectancy. However, upon the EDB's death, the subsequent beneficiary becomes subject to the 10-year rule, regardless of their own status.
This 10-year period begins in the year following the EDB's death, not the original account owner's death. The entire remaining balance must be distributed by December 31 of the tenth year following the EDB's death, with no requirement for annual distributions within this period. This rule effectively ends the possibility of multi-generational "stretching" of inherited IRAs beyond the life of the first EDB, a significant consideration for long-term estate planning strategies involving retirement accounts.
Transition When an EDB Passes Inherited IRA to another EDB:
When an Eligible Designated Beneficiary (EDB) dies and the account passes to another individual who also qualifies as an EDB, the new beneficiary may continue to receive distributions based on their own life expectancy. This new EDB does not become subject to the 10-year rule that applies to non-EDB heirs. Instead, they can "reset" the distribution schedule based on their own life expectancy.
New Rules for Calculating RMDs When an Annuity is Purchased:
The regulations provide updated guidance for situations where a portion of a retirement account is used to purchase an annuity. Under the new rules, plan participants may elect to have the RMD amount calculated as the excess of the total required amount over the annuity payments received for the year.
This total required amount is determined by including the value of the annuity contract in the account balance. This approach allows for more flexibility in managing RMDs when annuities are involved and potentially reduces the amount that must be distributed from the remaining account balance.
Updated Guidance on Multiple Beneficiaries and Separate Accounting:
The regulations clarify how to handle situations with multiple beneficiaries. They provide that if an IRA owner has more than one designated beneficiary, the beneficiary with the shortest life expectancy will generally be used to determine the distribution period.
However, the regulations also allow for separate accounting in certain circumstances. If the account is divided into separate shares or separate accounts for different beneficiaries by December 31 of the year following the account holder's death, each beneficiary's share may be treated separately for RMD purposes. This can be particularly advantageous when beneficiaries have significantly different life expectancies or when some beneficiaries qualify as eligible designated beneficiaries while others do not.
Clarifications on How to Handle RMDs in the Year of Death:
The regulations provide important guidance on managing RMDs in the year of an IRA owner's death. If the account owner dies before taking their full RMD for the year, the beneficiary is responsible for taking the remaining RMD amount for that year.
The regulations clarify that this remaining RMD may be taken by any beneficiary, not necessarily proportionally by all beneficiaries. This provides flexibility in satisfying the RMD requirement for the year of death. Additionally, the regulations address how to calculate RMDs for beneficiaries in subsequent years, which can vary depending on whether the account owner died before or after their required beginning date and whether the beneficiary is an eligible designated beneficiary.
Final Thought:
These regulations provide much-needed clarity on RMD rules following recent legislative changes. As financial advisors, it is important to understand these changes and clarifications to provide accurate guidance and identify client planning opportunities.
If you have clients or prospects with large IRAs or 401(K) rollovers, please contact the Dunham Business Development Team at (858) 964-0500.
Our Business Development Team can provide valuable information on strategies to eliminate the 10-year tax imposed by the SECURE Act on IRA beneficiaries, which could be the key to winning a large rollover account.
They are prepared to discuss solutions that may help your clients or prospects disinherit the IRS, help you sell more life insurance, and place guardrails around the assets for beneficiaries such as special needs and substance abuse heirs.
Sources:
- Required Minimum Distributions, by Federal Register, July 19, 2024, Federal Register :: Required Minimum Distributions
Disclosure:
This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax, or investment advice or an investment recommendation, or as a substitute for legal counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy, or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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