Dec 13, 2022

Update on Post-Death Distributions from Inherited IRAs and Retirement Plans

By Ashley G. White, JD, CPA

The SECURE Act of 2019 was signed into law late in 2019 and largely overhauled the existing rules regarding taking mandatory distributions from retirement plans, both during the lifetime of the plan participant and during the life of the plan participant’s beneficiary after the death of the participant.  Many of the changes were taxpayer-friendly, such as the increase in the age at which participants must take required minimum distributions (RMDs) from 70 ½ to 72 and the ability to include certain part-time employees in 401(k) plans.  However, the ability of a plan participant’s beneficiary to stretch distributions across the life expectancy of the beneficiary (traditionally known as the “stretch IRA”) was restricted to a new category of beneficiaries known as “eligible designated beneficiaries.”  For those beneficiaries who do not qualify as eligible designated beneficiaries (most adult non-spouse beneficiaries), distributions must be completely taken within ten years of the participant’s death.

Proposed regulations were issued earlier this year and were originally supposed to go into effect beginning in 2022.  The most noteworthy item comes from guidance regarding RMDs following the death of a plan participant who dies after reaching age 72. Specifically, the proposed regulations state that a beneficiary who inherits an IRA or retirement plan from a plan participant who dies after reaching age 72 will be required to take distributions beginning on the first calendar year following the year of the decedent’s death, each year until the tenth year following the calendar year of the decedent’s death, at which time all of the remaining funds must be distributed outright to the beneficiary.  This came as a surprise to many practitioners and commentors who were under the impression that beneficiaries that were subject to the 10-Year Rule would not be required to take ANY distributions until December 31 of the tenth year following the decedent’s death, no matter how old the plan participant was at the age of death.

By contrast, when the IRA owner or retirement plan participant dies before reaching the age of 72, there are no annual RMDs under the 10-Year Rule. In this case, only the 10-Year Rule payment must be satisfied. In fact, the non-eligible designated beneficiary can take as little or as much as he or she wants during years one through nine, as long as the entire account balance is distributed by the end of the ten-year term.

Just as with the failure to take an RMD while alive, failure to take the required RMD by a beneficiary who is required to take it under the regulations has severe consequences:  specifically, a 50 percent excess accumulation penalty. The same 50 percent penalty applies to failure to withdraw the remaining amount by December 31 of the tenth year, and it will continue to be imposed each year beyond year ten that the funds remain in the account.  Note that this is in addition to the ordinary income tax rates imposed when the funds are withdrawn.

In response to the concerns expressed by many affected taxpayers, the IRS recently issued Notice 2022-53, which states that updated final regulations for RMDs will not apply before the 2023 distribution calendar year.  In addition, the notice provides relief for those taxpayers that failed to take RMDs in 2021 or 2022 under the new 10-Year Rule.  Specifically, individuals who didn’t take specified RMDs will not be subject to the excess accumulation penalty, and for those who have already paid the penalty, a refund can be requested.  The relief is limited to those beneficiaries under a defined contribution plan or IRA where the plan participant/IRA owner died in 2020 or 2021 and on or after the plan participant’s or IRA owner’s beginning RMD date. The presumption is that taxpayers are expected to comply with the proposed regulations regarding the 10-Year Rule for deaths occurring in 2022 and beyond, at least until final regulations are issued.  If you have any questions about how these rules affect you or your loved one, please reach out to your trusted BMSS advisor at (833) CPA-BMSS or visit our website for contact information.