How to Handle Complex Beneficiary Scenarios Following Recent Changes
By Carrie Horn, CISP, CHSP, QPA, TGPC
One of our IRA clients died in 2020 at the age of 73. His sister, who was age 66 that year, has not done anything with the IRA. What are we, as the IRA custodian, required to do with this IRA?
Because the IRA owner died in 2020, we need to determine if the beneficiary is a designated beneficiary or an eligible designated beneficiary. In this scenario, the beneficiary is considered an eligible designated beneficiary because she is not more than 10 years younger than the deceased account owner.
Because the account owner died after his required beginning date, his sister may either take a lump sum distribution or continue taking payments at least as rapidly as the account owner. The minimum annual payments are based on her own single life expectancy (because she was younger than the account owner) beginning in 2021, reducing the factor by one each subsequent year. If the beneficiary has not done anything with this inherited IRA, she will owe a 50 percent excess accumulation penalty tax for any missed payments. For example, we know that the 2020 required minimum distributions (RMDs) were waived for all IRA owners and beneficiaries, so there will be no penalty for 2020. But because the beneficiary should have been taking payments from the IRA starting in 2021, she would owe a 50 percent excess accumulation penalty tax on any amount that should have been removed but was not.
It is the beneficiary’s responsibility to report and pay any penalty taxes that are due, or possibly request a waiver of the penalty taxes owed, for the missed payments with her tax return for that year. She does this by filing IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts to pay the penalty tax or request a waiver of the penalty tax.
Your financial organization is not required to do any special reporting for the missed payments or provide any notification to the beneficiary of her required payment amount. Some IRA documents may provide the IRA custodian options, such as forcing a lump-sum payout to the beneficiary, when a beneficiary does nothing by the required payment date. Check your IRA document to see if it provides additional options to your organization as the custodian.
Your organization is responsible only for proper tax reporting on this inherited IRA. This includes generating IRS Form 5498, IRA Contribution Information, each year for this inherited IRA to show the year-end balance. This form is required to be generated even if the beneficiary has not done anything with the account.
We have an IRA owner who died in 2018 at age 70. His spouse, who was age 69 when he died, is his sole IRA beneficiary. The spouse had chosen the five-year payout option but has now changed her mind and wants to transfer it to her own IRA instead. Can she still do this?
The regulations state that a spouse may “treat as own” by
“redesignating” (transferring) the account to her own IRA,
failing to take a required distribution by the applicable deadline, or
making a regular IRA contribution to the account.
A spouse beneficiary may also move the inherited assets to her own IRA by taking a distribution and rolling it over to her own IRA within 60 days. This does not fall into the “treat as own” election described under the regulations, and can be done at any time as long as the spouse is eligible to complete a rollover.
Proposed Treasury Regulation 1.408-8(c)(1)(ii) has created a deadline for spouse beneficiaries to elect to treat an IRA as their own. A spouse must now elect to treat an IRA as her own by the later of 1) the calendar year in which the spouse beneficiary reaches age 72, or 2) the calendar year following the calendar year of the account owner’s death. The proposed treasury regulations did not grandfather in any accounts that were inherited before 2020, so it appears that all inherited IRAs are now subject to this deadline for a spouse beneficiary to treat the IRA as her own. In the situation that you describe, because the spouse beneficiary reached age 72 in 2021, she would have had to treat the IRA as her own by December 31, 2021. The regulations, however, do not create a deadline for a spouse beneficiary to take a distribution from the inherited account and roll it over to her own IRA, so she would still be able to move it her own IRA in this manner.
To complicate matters even more, the proposed treasury regulations place another restriction on spouse beneficiaries in this situation. If an account owner died before his required beginning date (or had a Roth IRA) and the spouse beneficiary had elected the 5-year rule (or 10-year rule for deaths after 2019) and rolls over the account to her own account in a year that she is age 72 or older, she must calculate a “hypothetical RMD” when determining how much is eligible to be rolled over. The hypothetical RMD is an amount that would have been required had the beneficiary been taking life expectancy payments instead of using the 5-year or 10-year rule. The beneficiary in this situation would need to calculate a hypothetical RMD for 2021 (age 72) and 2022 (age 73) based on her own single life expectancy in those years. The calculated amounts would not be eligible to be rolled over to her own IRA and are required to be distributed to her.
I know that the SECURE Act created a new 10-year option for IRA beneficiaries to use when they inherit an IRA in 2020 or later. I had been told that the beneficiary would have 10 years from the year the IRA owner died to deplete the account, with no requirements for an annual payment. But now I am hearing conflicting information stating that there is a required annual distribution. Will you please clarify whether the 10-year rule requires an annual payment each year?
The SECURE Act created a 10-year payment option available for most beneficiaries to use, regardless of whether the IRA owner died before, or on or after, his required beginning date (RBD). The RBD is generally April 1 of the year following the year the IRA owner reached age 72 (70½ if born before July 1, 1949). When this rule went into effect in 2020, it was interpreted to mean that there was no annual distribution required under the 10-year option, regardless of whether the IRA owner died before, or on or after, his RBD. The only requirement appeared to be that the beneficiary must deplete the IRA by December 31 of the year containing the tenth anniversary of the IRA owner’s death.
In February 2022, the IRS released proposed regulations that provided its interpretation of the SECURE Act rules and completely rewrote the RMD regulations for IRA owners and beneficiaries. In these proposed regulations, the IRS clarifies that if the IRA owner dies on or after his RBD, payments to the beneficiary are required to continue “at least as rapidly” as they were being made to the account owner, meaning that annual payments had to continue to the beneficiary even under the 10-year option. The regulations allow the beneficiary to calculate the annual payment for the first 9 years over the longer of the deceased account owner’s single life expectancy, or the beneficiary’s single life expectancy. For example, if an IRA owner died at age 75 and left his Traditional IRA to his son, who was age 50, his son would have to take annual payments from the inherited IRA based on his own single life expectancy for the first 9 years with a total distribution of the inherited IRA required by the end of the tenth year after the IRA owner’s death.
Because of the original interpretation of the 10-year option to not require annual payments, a beneficiary who had inherited an IRA from an IRA owner who died on or after his RBD in 2020 may not have taken a payment in 2021. On October 7, 2022, the IRS issued Notice 2022-53, which states that certain beneficiaries who failed to take payments will not be assessed a 50 percent excess accumulation tax. This relief is limited to distributions required to be made in 2021 or 2022 under the new 10-year rule in a defined contribution plan or IRA for a designated beneficiary if
the account owner died on or after the RBD in 2020 or 2021, and
the designated beneficiary is not taking life expectancy payments.
The same relief under the new 10-year rule also applies to a successor beneficiary of an original eligible designated beneficiary if
the eligible designated beneficiary died in 2020 or 2021, and
that eligible designated beneficiary was taking life expectancy payments.
Going forward, the beneficiary should be aware that annual payments for the first 9 years are required when using the 10-year option upon inheriting an IRA from someone who died after his required beginning date.
