On July 19, 2024, the Internal Revenue Service released the long-awaited final regulations on required minimum distributions for individual retirement accounts and employer plans. Two of the main rules addressed in these regulations are whether a particular beneficiary must take annual RMDs and whether such a beneficiary can get an extension to the 10-year limit. With the clarifications, it is now established that certain 10-year beneficiaries must take annual RMDs and not receive an extension of their 10-year term.
How we got here
The Community Pension Increase Determination Act of 2019 (the SAFE Act), enacted December 20, 2019, as Division O of the Consolidated Appropriations Act, 2020, Public Law 116-94, 133 Stat. 2534 (2019), changed the options available to beneficiaries who inherit IRAs and employer plan accounts (retirement accounts) after 2019. One of the most significant changes requires designated beneficiaries and designated successor beneficiaries to distribute the accounts they inherit within 10 years. Previously, designated beneficiaries and successors could receive distributions for the entire applicable life expectancy of the designated beneficiary.
Before the SAFE Act was enacted, a 5-year rule applied when the IRA owner or plan participant died before the required beginning date (RBD). This rule required beneficiaries to distribute all assets in the IRA by the fifth year after the year in which the participant died.
SECURE Act language for the new 10-year rule states:
In the case of a defined contribution plan, if an employee dies before the employee's entire interest is distributed—
“(i) IN GENERAL.—Except in the case of a beneficiary who is not a designated beneficiary, subparagraph (B)(ii)—
“(I) shall be implemented by substituting “10 years'' for “5 years'', and
“(II) shall apply whether or not distributions of the employee's interests have commenced pursuant to subparagraph (A).
This language signaled that beneficiaries subject to the 10-year rule had the option of not receiving distributions until the 10th year after the participant's death. They must fully dissolve the account at that time. As indicated in the language, this applies regardless of whether the participant died before their RBD.
ALAR rule
The proposed regulations (87 FR 10504) in these final rules included a reminder that the SURE Act did not repeal the “at least as soon as possible” (ALAR) rule. As a result, any beneficiary who inherits a retirement account from an owner who was already required to begin taking RMDs must continue to take distributions at least as fast as the rate at which the participant was taking distributions. Because the only life expectancy table that can be used to calculate RMDs for a beneficiary account is a Single Life Expectancy Table, under the ALAR rule, beneficiaries must continue to take distributions and calculate them using the life expectancy table. Single Lifespan.
Designated beneficiaries now subject to the 10-year rule are not exempt from this ALAR provision. This means that a designated beneficiary who inherits a retirement account after 2019 from someone who died on or after the RBD must take the annual RMD. These annual RMDs will be calculated over the single life expectancy of the designated beneficiaries and are required to begin no later than the year following the year the participant dies.
This requirement to continue receiving annual RMDs also applies to successor beneficiaries who inherit the retirement accounts of certain qualified beneficiaries receiving lifetime distributions. For this purpose, qualified designated beneficiaries include designated beneficiaries who inherited retirement accounts prior to 2020.
The IRS received many complaints in response to the ALAR. Most stated that some of these beneficiaries did not receive DRM because they felt they should not. Now, those beneficiaries will have to pay a 50% excise tax (reduced to 25% starting in 2023) on the RMDs they didn't receive because of the deceptive language in the SAFE Act.
Automatic removal of excise duty
In response to the complaints, the IRS issued Notice 2022-53, Notice 2023-54, and Notice 2024-35, which provide that the excise tax is automatically waived for affected beneficiaries who inherited retirement accounts from 2020 to 2023 and have not done so. receive their RMDs from 2021 through 2024. These beneficiaries do not have to file the required IRS Form 5329 to claim the excise tax exemption.
As indicated in Notice 2024-35, the automatic waiver ends in 2024. Therefore, these beneficiaries must take appropriate RMDs in 2025 and after or be subject to a 25% excise tax on any RMD deficiency.
Taxpayers wanted to know if the 10-year period had been extended as a result of these waivers. The proposed regulations confirmed that it was not. Therefore, a beneficiary who inherited a retirement account in 2021, for example, must take annual RMDs and fully distribute the account no later than 2031.
Beneficiaries affected
The 10-year rule applies to four classes of beneficiaries after 2019.
- A designated beneficiary who inherits a retirement account from an owner who died before their RBD, which is April 1 of the year following the year of their first RMD. In this case, distributions are optional until the 10th year, when any remaining balance must be distributed in full.
- A qualified designated beneficiary who inherits a retirement account from someone who died before the RBD. Here again, distributions are optional until the 10th year, when the account must be fully distributed. A qualified designated beneficiary can choose between this 10-year rule and the lifetime rule under which distributions can be taken for their entire lifetime.
- A Designated Beneficiary who inherits a Retirement Account from a Participant who died on or after his RBD. In this case, the designated beneficiary must take annual distributions over their lifetime and empty the account by the 10th year after the year of the account owner's death.
- A successor beneficiary who inherits a retirement account from a designated qualified beneficiary who was receiving lifetime distributions. The successor beneficiary must continue to receive distributions at the same rate as the primary beneficiary. In addition, the successor beneficiary must ensure that the account is fully distributed by the 10th year after the year the designated eligible beneficiary died.
The annual RMD requirement and the automatic elimination of the excise tax impact beneficiaries listed in numbers three and four.
What will happen next for these beneficiaries?
The automatic excise tax waiver is a welcome solution for affected beneficiaries who failed to receive their 2021 DRMs until 2024. However, these beneficiaries must ensure that any required RMDs for 2025 are received by on December 31, 2025. Missing this deadline means they owe the IRS a 25% excise tax on each RMD deficiency. If they miss the deadline due to reasonable error, their tax preparer can file IRS Form 5329 and request a waiver of the excise tax.
Beneficiaries should also consider the tax impact of accumulating distributions over a shorter time frame. For example, a beneficiary who inherited a retirement account in 2020 and did not receive any distributions until 2025 has only six years to distribute the account. If the amount is significant, it may have an adverse tax impact on taxable distributions. However, the opposite may be true for some beneficiaries, as there may be times when it is tax efficient to minimize distributions from their retirement accounts. Beneficiaries should consult their tax advisor about when to take distributions and how much to take each year to maximize tax efficiency.