Proposed RMD Rule Changes May Impact Your IRA

Proposed Regulations:  IRS Required Minimum Distribution Rules Contain Some Surprises

In late 2019, Congress passed the SECURE Act (the Act). The Act made significant changes to the tax rules related to Required Minimum Distributions (RMDs) from IRAs and employer sponsored retirement plans.

Overview of Changes Contained in the SECURE Act Related to RMDs

• The Act increased the age for taxpayers to start taking RMDs from age 70.5 to age 72. Individuals that had not turned age 70.5 by the end of 2019 could wait until April 1 of the year following the year they turned age 72 to take their first RMD.
• The Act eliminated the so-called stretch IRA RMD rules for inherited IRAs. Under the SECURE Act rules for inherited IRAs, non-spousal beneficiaries of inherited IRAs must take all of the funds out of the IRA by the end of the 10-year period following the death of the IRA owner.
• Under the SECURE Act, an “ELIGIBLE” designated beneficiary may still calculate RMDs using his/her life expectancy and not the 10-year payout rule. An ELIGIBLE designated beneficiary is the surviving spouse, a child who has not reached the age of majority, disabled persons, chronically ill persons, or persons not more than 10 years younger than the employee/IRA owner.

Last week the IRS and Treasury issued 275 pages of proposed regulations that update the RMD rules for changes made by the SECURE Act.

Minor Child Definition Change

Under the proposed regulations, a minor child is defined as a child under the age of 21, even though a particular state may define the age of majority as age 18. As an ELIGIBLE beneficiary, a minor child may take RMDs using his/her life expectancy until turning age 21. Once age 21 is reached the beneficiary must follow the 10 year-payout rule for the remaining funds.

Planning Point:  Taking RMDs based on the minor child’s life expectancy until age 21 will likely result in relatively small RMDs and preserve much of the tax deferral for a bit longer.

RMD Changes for Inherited IRAs

The proposed regulations contain a big surprise for non-spouse taxpayers who inherit IRAs where the IRA owner had already begun taking RMDs. The proposed regulations focus on the “required beginning date” which is April 1 of the year after the IRA owner turns 72.  Under the proposed regulations if a non-spouse taxpayer inherits a traditional IRA from someone who reached the “required beginning date” for RMDs, that beneficiary must take RMDs in each year 1 thorough 9 based on their own life expectancy. The remainder of the IRA must then be withdrawn in year 10.

This proposed regulation takes a position on the 10-year pay-out rule that is different from the way most experts had interpreted the 10-year payout rule of the SECURE Act. In fact, the proposed regulations reverse the IRS position issued in IRS Publications concerning IRA distributions that was updated in May 2021.

Depending on the effective date of the proposed regulations, taxpayers who inherited IRAs in 2020 and 2021 that did not comply with the proposed regulations on payouts could have penalty exposure for not taking the RMD under the proposed regulations. Reminder that the CARES Act, suspended IRA distributions for 2020, so potential exposure is limited to 2021.  Hopefully, the final regulations will include relief provisions or correction provisions for those taxpayers who may have missed RMDs in 2021.

Planning Point:  While taxpayers must (potentially) take RMDs in years 1 to 9, it might be advantageous to take a larger distribution than the RMD so that you can more evenly spread out the income and balance the tax due.  Fluctuations in the taxpayer’s other income and/or deductions would also have an impact on determining how much to take out annually over the 10 year period.

It should be noted that if the traditional IRA owner passes before reaching the “required beginning date” then the IRA beneficiary does not have an annual RMD requirement and has more flexibility as to when to withdraw the IRS over the 10 year period.  The only requirement is that all of the traditional IRA is withdrawn by the end of the 10 year period.

Planning Point:  As with traditional IRAs that require RMDs, taxpayers should consider if it would be advantageous to take at least some distribution each year so that the income is more evenly recognized, and the resulting tax liability is minimized.  The taxpayer’s other income and/or deductions would also have an impact on determining how much to take out annually over the 10 year period.

What if you potentially missed an RMD in 2021?

If you are a taxpayer caught up in the new rules from the proposed regulations, we generally recommend waiting until the end of 2022 before taking corrective action.  By then the IRS should have issued final regulations or guidance that could provide relief for not taking the RMD in 2021.

Are Inherited Roth IRAs Subject to RMD Rules?

Non-spouse beneficiaries of qualifying Roth IRAs, including Roth conversion IRAs, are not subject to the RMD rules during the 10 years following the IRA owner’s death.  As a result, a non-spouse beneficiary of a Roth IRA does not have to take the funds out of the Roth IRA until year 10.

Example:  Jane Doe is age 73 and has already started taking RMDs from her regular IRA. On February 1, 2022, Jane converted her all of her traditional IRA to a ROTH IRA. As a result of the conversion, her ROTH IRA is no longer subject to the RMD rules. Even though she had taken an RMD from the former traditional IRA, her beneficiaries can wait until year 10 to take all of the funds out of the ROTH IRA once Jane pass away.

Planning point:  As there is no tax due (under current law) on ROTH IRA distributions, it is suggested that beneficiaries leave all (or as much as they can) in the ROTH IRA until the very end of the 10 year period to maximize the permanently tax free appreciation.

Effective Date of Proposed RMD Rule Change

The IRS is accepting comments on the regulation through May 25, 2022, with a hearing scheduled June 15, 2022. As a result, the final regulations will probably not be issued until sometime this summer.

For the 2021 distribution calendar year, RMDs should be determined under the current RMD regulations but taking into account a good faith interpretation as to how the existing regulations were amended by the SECURE Act.

Keiter will continue to monitor action on the proposed regulations and provide updates to our clients and friends. If you have questions on this or other wealth tax matters, please contact your Opportunity Advisor or Email | Call: 804.747.0000. We can advise you on strategic estate tax savings and planning opportunities that best fit your unique needs.