On Feb. 24, 2022, the Internal Revenue Service issued proposed regulations addressing changes to required minimum distribution rules made by the SECURE Act, enacted at the end of 2019. The SECURE Act had changed the required beginning date for RMDs from April 1 of the calendar year after the individual turns age 70 ½ to the year after the individual turns age 72.
The act also replaced the use of the beneficiary’s life expectancy as the distribution period for designated beneficiaries with a 10-year distribution period unless the designated beneficiary is a qualified designated beneficiary. The age change for RMDs was made effective after Dec. 31, 2019, for individuals who attain age 70 ½ after such date. The changes to the required distribution rules were effective for distributions with respect to participants who die after Dec. 31, 2019.
Eligible designated beneficiary
The proposed regulations clarify who may be considered an eligible designated beneficiary and qualify to use their life expectancy for RMD purposes. Eligible designated beneficiaries include:
- The surviving spouse of the participant;
- A child of the participant until reaching the age of majority;
- Someone who is disabled or chronically ill; or,
- Someone who does not fall under one of these other categories and is not more than 10 years younger than the participant.
The proposed regulations address the definition of the age of majority, the definition of disability and required documentation, and other related rules. Majority is defined as being reached on the child’s 21st birthday, although defined benefit plans that have used a prior permitted definition are allowed to continue to use the prior definition. Disability is based generally on whether the individual is unable to engage in substantial gainful activity. For a beneficiary under age 18, the disability standard is whether the beneficiary has a medically determinable physical or mental impairment that results in marked and severe functional limitations that can result in death or be of long-term and indefinite duration. A safe harbor is also provided to use the Social Security determination of disability applied as of the date of the employee’s death. The onset of a disability in the beneficiary after the employee’s death is not taken into account for RMD purposes.
The proposed regulations discuss at length the treatment of a trust as a beneficiary, including taking into account see-through trust beneficiaries, disregarded beneficiaries of see-through trusts, identifiability of trust beneficiaries, and multiple beneficiary trusts. The designation of multiple beneficiaries outside of the trust context is also addressed.
Distribution requirements
Internal Revenue Code Sec. 401(a)(9)(B)(i) provides that, when the participant reaches their required beginning date, the distributions after the death of the participant must be made at least as rapidly as under the method of distributions being used as of the date of the participant’s death. The use of the life expectancy of the beneficiary where distributions the participant had been taking were based on the participant’s life expectancy was considered to meet this requirement.
When the SECURE Act imposed a 10-year limit on distributions by a beneficiary who was not an eligible designated beneficiary, some people interpreted the act as providing that the distribution requirement was met as long as the distributions occurred within the 10-year period. The IRS seemed to be supportive of this view when it removed a reference to the Code Section401(a)(9)(B)(i) language from a draft of Publication 590-B. However, the proposed regulations provide that, if an employee or IRA owner dies on or after the required beginning date of distributions, the beneficiaries, except for spousal beneficiaries, must take annual distributions in years one through nine based on the designated beneficiary’s life expectancy.
The requirement for continued annual distributions is of particular concern to planners and taxpayers due to the substantial 50% penalty that applies to failing to make required minimum distributions. Some argue that the intent of Congress in imposing the 10-year distribution rule was to simplify planning and make it easier to avoid the distribution penalty. The proposed regulations, however, would continue the requirement for annual calculations of required minimum distributions in addition to a final distribution in the tenth year. In the case of multiple beneficiaries, the age of the oldest beneficiary will be the basis for the amount of the annual RMD even for younger beneficiaries.
These are only proposed regulations; however, the IRS has stated that they may be relied upon starting Jan. 1, 2022. Should planners advise their clients in this situation to make an RMD for 2022, not make an RMD, or wait until closer to the end of 2022 to see if the IRS clarifies the situation in final regulations or other guidance? If the beneficiary would prefer to hold off distributions as long as possible, those beneficiaries may prefer to hold off and hope for clarifying guidance this year.
Required beginning date
The proposed regulations clarify that if the participant’s birthdate is prior to July 1, 1949, the age for the required beginning date remains at 70 ½. If the birthdate is on or after July 1, 1949, the age for the required beginning date is 72 regardless of whether the participant survived to age 70 ½.
Effective date
The proposed regulations include an effective date of Jan. 1, 2022, and taxpayers may rely on the proposed regulations now for distributions in 2021 as well.
Summary
The proposed regulations are 275 pages in length and do add important clarifications to the required minimum distribution requirements of the SECURE Act in a number of areas. The rule requiring annual distributions in years one through nine were unanticipated by many observers as appearing contrary to the initial position of the IRS, contrary to the intent of Congress in adopting a 10-year rule, and adding additional complexity for taxpayers and exposing them to heavy penalties.
Congress is still working on SECURE 2.0 and may clarify its position in that legislation. The IRS may also revisit the issue in final regulations or at least consider waiving penalties for distributions that may not have met current requirements due to the confusion.
