Recently Proposed IRS Regulations on New 10-Year RMD Rule Are a Surprise – Part 2

This is the second of a three-part presentation on recently issued IRS proposed regulations explaining Setting Every Community Up for Retirement Enhancement (SECURE) Act rules for required minimum distributions (RMDs) on inherited IRAs and qualified retirement plans and the 10-year payment rule. The rules apply to RMDs of beneficiaries of traditional IRA owners and workplace retirement plan participants who die after Dec. 31, 2021.

The proposed regulations are a surprise to many financial advisors. The first column discussed how the 10-year payment rule applies to inherited traditional IRAs and to workplace retirement plans including the Thrift Savings Plan (TSP). This column discusses RMD rules for inherited Roth IRAs and for successor beneficiaries of traditional inherited IRAs and workplace retirement plan participants.

RMD Rules for Inherited Roth IRAs

When a Roth IRA owner dies at any age, there are no annual RMDs under the 10-year payment rule. That is because Roth IRAs as a rule have no required beginning date (RBD) and therefore no RMDs. For example, a Roth IRA owner who dies at age 100 is still deemed to have died before his or her RBD. Nevertheless, under the SECURE Act the inherited Roth IRA of a non-spousal beneficiary must be withdrawn in its entirety by the end of the 10th year of the year after the Roth IRA owner dies. The following example illustrates:

Example 1.

Shirley, age 56, is the beneficiary of her father Ronald’s Roth IRA. Ronald died on March 2,2022 at age 84. As a Roth IRA owner, Ronald is considered to have died before his RBD, even though he died after age 70.5. Therefore, Shirley does not have to take annual RMDs from her inherited Roth IRA. But Shirley must withdraw her inherited Roth IRA account by December 31,2032. She will owe no federal and state income taxes on any of the inherited Roth IRA amounts withdrawn.

The fact that a Roth IRA beneficiary does not have to take RMDs in years 1 through 9 of the required 10-year payout period allows the inherited Roth IRA funds to accumulate and grow tax free for the full 10-year term. That can potentially benefit both individual and trust beneficiaries. It may also be a good reason for federal employees to contribute to the Roth TSP and/or Roth IRAs, or to convert traditional IRAs to Roth IRAs, in spite of the fact that all inherited Roth IRA funds have to be withdrawn by the end of the 10-year payout period.

Rules for Successor Beneficiaries

A successor beneficiary is a beneficiary who inherits from the deceased original beneficiary of an inherited IRA or workplace retirement plan. Under the SECURE Act, the general rule is that a successor beneficiary is subject to the sane 10-year payment rule as was the original beneficiary. But the IRS regulations make clear that the application of the 10-year rule will depend on two factors, namely: (1) Whether the traditional IRA owner or retirement plan participant died before or after his or her RBD; and (2) whether the original beneficiary was an eligible designated beneficiary (EDB) (for example, a spouse).

Note an individual’s RBD is determined by his or her date of birth. For IRA owners and qualified retirement plan participants who were born before July 1, 1949, the RBD is April 1 following the year the IRA owner or qualified retirement participant became age 70.5. For IRA owners and qualified retirement plan participants who were born after June 30, 1949, the RBD is April 1 following the year the IRA owner or qualified retirement plan participant becomes age 72.

If the traditional IRA owner or retirement plan holder dies before his or her RBD and the original beneficiary is subject to the 10-year rule, then the successor beneficiary will be subject to the same 10-year period as the original beneficiary. No annual RMDs are required in years 1 through 9 of the 10-year payment period. The following example illustrates:

Example 2.

Julie, age 69, died in January 2022. Her traditional IRA beneficiary is her daughter Kathy, age 42. Kathy is subject to the 10-year payment rule. Kathy names her 21-year-old daughter Liz as a successor beneficiary. Kathy died unexpectedly in April 2022. Liz is bound by the same 10-year payout period as her mother. Liz therefore must empty the inherited traditional IRA by Dec. 31, 2032, paying federal and state income taxes on her traditional IRA withdrawals. Note that since Julie died before her RBD, Kathy and now Liz are not subject to RMDs during years 1 through 9 of the 10-year payment period.

If the IRA owner or retirement plan holder dies after his or her RBD and the original beneficiary is subject to the 10-year rule, then the successor beneficiary will be subject to the same 10-year “window” as the original beneficiary. Annual RMDs are required in years 1 through 9 of the 10-year payout period by both the original beneficiary and the successor beneficiary. Both periods of annual RMDs are calculated based on the life expectancy of the original beneficiary. The following example illustrates:

Example 3.

Charles, age 83 and the owner of a traditional IRA, died in February 2022. Charles had named his son David, age 53, as the beneficiary of his traditional IRA. Charles died after his reaching his RBD. That means David is subject to the 10-year payment rule and must take annual RMDs over his life expectancy during years 1 through 9, starting in 2023. David names his daughter Eve as a successor beneficiary. David died in 2025. Eve continues the same 10-year payout period and must empty the inherited IRA by Dec. 31, 2032. Eve must continue annual RMDs in years 4 through 9 of the 10-year period (2026 – 2031). Sometime before Dec. 31,2025, David’s RMD for the year 2025 must have been taken based on David’s single life expectancy

If the IRA owner or retirement plan participant dies on or after his or her RBD and the original beneficiary who is an eligible designated beneficiary (EDB) dies thereafter, then the successor beneficiary is subject to a 10-year payout period. The 10-year payout period starts in the year after the year the EDB dies. Annual RMDs based on the original beneficiary’s life expectancy must be paid to the successor beneficiary in years 1 through 9 of the 10-year payout period, and the entire account must be emptied by the end of the 10th year following the year of the EDB’s death. The following two examples illustrate:

Example 4.

Lester, age 75, dies in March 2020 and leave his traditional IRA to his brother Allan, age 67. Allan is an EDB and can take annual RMDs from his inherited traditional IRA based on his life expectancy. Allan names his daughter Rachel as the successor beneficiary. Allan died in early 2022. Rachel is subject to the 10-year payment rule. She must empty the inherited IRA by Dec. 31, 2032. During the 10-year period, Rachel must make annual RMDs based on her father Allan’s single life expectancy.

Example 5.

Gene was a federal retiree with a traditional TSP account who died In November 2020 at the age of 74. Gene had named his wife Susan (age 69 at the time of Gene’s death), as the sole beneficiary of his TSP account. Shortly after Gene died, Susan established a TSP beneficiary account and named her son Michael as a successor beneficiary to her inherited TSP account. Susan died in March 2022. As a successor beneficiary, Michael requested from the TSP to do a direct transfer of his inherited TSP account to an inherited traditional IRA. Michael is subject to the 10-year payment rule of his inherited traditional IRA. He must withdraw the entire inherited traditional IRA no later than December 31, 2032. In addition, during years 1 through 9 of the 10-year payout period, Michael must take RMDs each year based on his mother Susan’s life expectancy at the time of her death (age 71).