Recently Proposed IRS Regulations on New 10-Year RMD Rule Are a Surprise – Part I

In late December 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was passed by Congress and became law effective Jan. 1, 2020. Among the provisions of the SECURE Act was that most non-spousal beneficiaries of IRA owners who died after Dec. 31,2019 cannot receive lifetime distributions based on the designated beneficiary’s life expectancy.

In its place, a non-spousal beneficiary is subject to a 10-year rule under which all of the inherited IRA funds must be withdrawn by the end of the 10th year after the death of the IRA owner.

On Feb. 23, 2022, a little over two years following the SECURE Act passage, the IRS released SECURE Act proposed regulations for required minimum distributions (RMDs). These proposed regulations were a surprise to many financial advisors.

In particular, the major surprise is the IRS’ interpretation of how the 10-year rule applies to certain individual retirement accounts and workplace retirement plan beneficiaries.

The IRS explained that when death occurs after the required beginning date (RBD) of a traditional IRA or workplace retirement plan holder (normally April 1st following the year he or she becomes age 72), RMDs will be required for years 1 through 9 following the year of the death of the IRA owner or retirement plan holder. By the end of year 10 following the year of death of the IRA owner or retirement plan holder, the entire remaining balance in the inherited IRA or retirement plan will have to be withdrawn by the beneficiary.

It is important to note that the SECURE Act eliminated the so-called “stretch IRA” for most non-spousal beneficiaries. In place of the “stretch” IRA, in which any IRA beneficiary could receive inherited IRA funds spread over his or her life expectancy, is a 10-year rule in which all inherited retirement funds must be withdrawn by the end of the 10th year after the death of the IRA owner.

The SECURE Act created exceptions for the 10-year payout for certain IRA beneficiaries called “eligible designated beneficiaries” (EDBs). EDBs include surviving spouses, minor children of the deceased IRA owner until the children become age 21, disabled and chronically ill beneficiaries, and designated beneficiaries who are no more than 10 years younger than the deceased IRA owner.

The New “At Least As Rapidly” Rule

Under the recently issued IRS regulations on RMDs resulting from the SECURE Act passage, a new rule known as the “at least as rapidly” (ALAR) rule has been created. To understand the significance of the ALAR rule, it is important to review what the RBD is with respect to RMDs.

The RBD is April 1st of the year following the year an IRA owner or qualified retirement plan participant (including a TSP participant) becomes age 72. A TSP participant who continues working in federal service past age 72 can delay their first TSP RMD until April 1st of the year following their retirement from federal service.

Under the recently issued IRS regulations, the RBD takes on new significance. This is because RMDs would be required for years one through nine if the IRS owner dies on or after his or her RBD but not if death occurred before his or her RBD.

It is important to understand that the ALAR was always part of the Internal Revenue Code for RMDs -even before the passage of the SECURE Act. That is, prior to Jan. 1,2020 any individual who inherited another individual’s IRA in which the individual died post-RBD (and therefore taking RMDs) has to withdraw the inherited IRA as the deceased IRA owner.

With the passage of the SECURE Act, many financial professionals thought that with the creation of the 10-year rule, no RMDs would have to be taken by an inherited IRA owner during years one through nine following the death of the IRA owner. The only RMD would have to be taken would be the balance in the inherited IRA at the end of the 10-year term.

To many retirement and tax professionals’ surprise, the IRS says “no” as elaborated under the recently issued regulations. The ALAR rule still applies and RMDs will be required for years one through nine. Note that while the ALAR rule does not require the IRA beneficiary to take the same RMD amount each year as the deceased IRA owner, it does require the beneficiary to continue RMDs. Under this rule, once lifetime RMDs begin, they must continue for a designated beneficiary based on the beneficiary’s life expectancy.

The following table summarizes the ALAR rule, the 10-year rule, and their implications:

*Both rules apply when the death of the IRA owner occurs on or after the required beginning date which is: (1) April 1st following the year the IRA owner becomes age 72 if the IRA owner was born after June 30,1949; and (2) April 1st following the year the IRA owner becomes age 70.5 if the IRA owner was born before July 1, 1949.

Note that if an IRA owner dies before his or her RBD and has designated as beneficiary a non-eligible designated beneficiary (non-EDB), then the non-EDB is subject to the 10-year rule with respect to the inherited IRA but is not subject to any RMDs during years one through nine. The entire inherited IRA balance would have to be withdrawn by the end of year 10; that is, December 31 of the 10th year following the death of the IRA owner.

The following two examples will illustrate:

Example 1. During 2021 Sheila, age 46, inherited a traditional IRA from her mother who died that year at age 75. As an adult child, Sheila is considered a non-EDB. Since Sheila’s mother died after her RBD, Sheila is subject to both the ALAR rule for years one thorough nine, and the 10-year rule for year 10.

Sheila is required to take annual RMDs based on her single life expectancy (age 46) during the first nine years, starting in 2022 and through 2030. By Dec. 31, 2031, the end of the 10th year, Sheila is required to withdraw any remaining balance in the inherited IRA. Note that if Sheila does not withdraw the RMD during years one through nine and any remaining balance by the end of year 10, she is subject to a 50 percent IRS excess accumulation penalty in any year in which she did not withdraw the required amount.

Example 2. During 2021, Jason, age 26, inherited a traditional IRA from his father who died that year at the age of 63. Jason is considered a non-EDB. Since Jason’s father died before his RBD, Jason is not subject to the ALAR rule but is subject to the 10-year rule. Jason can withdraw as little or as much from the inherited IRA each year during the 10-year period. But Jason would have to withdraw the entire amount of the inherited amount no later than Dec. 31, 2031.

In Example 2, an important consideration for Jason is income taxes. Since traditional IRA withdrawals are subject to federal and state income taxes, Jason may want to spread his required withdrawals over the 10-year period so as not to have to pay more in taxes in any one or more of the 10 years. For example, if Jason knows during a particular year his income will be reduced (for example, less salary or less investment income) he may want to withdraw more from his inherited IRA.