New RMD Guidance Brings Temporary Penalty Relief to Some Beneficiaries
By Jodie Norquist, CIP, CHSP
Certain IRA beneficiaries who are required to take out annual life expectancy payments under the 10-year-rule have been granted temporary penalty relief from the IRS.
The IRS released this new guidance, Notice 2022-53, on October 7, 2022. It affects beneficiaries of account owners who died on or after their required beginning date (RBD) in 2020 or later.
The Notice states that the IRS will not penalize beneficiaries for missed 2021 and 2022 life expectancy payments required under the 10-year payout option, waiving the 50 percent excess accumulation penalty tax that would normally apply if a payment is missed.
This is good news for clients who may not have known that annual payments are required under the proposed RMD regulations, which are to take effect retroactively as of January 1, 2022.
The 10-Year Rule Explained
The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), signed into law in December 2019, prohibits most nonspouse beneficiaries from “stretching” out their inherited IRA and retirement plan assets over their life expectancies. Instead, most nonspouse beneficiaries must now deplete their inherited assets within 10 years.
Death on or After the RBD
In February 2022, the IRS released its highly anticipated proposed RMD regulations. This guidance revises the existing RMD regulations and other related regulations and clarifies certain SECURE Act provisions.
The proposed RMD regulations contained an unexpected interpretation: if an account owner dies on or after their RBD, beneficiaries who are subject to the 10-year rule must also take annual life expectancy payments during the first nine years. These payments are based on the longer life expectancy of the deceased account owner or beneficiary.
Death Before the RBD
The proposed RMD regulations also confirm that for Roth IRA beneficiaries and beneficiaries of Traditional IRA owners and plan participants who die before their RBD, the 10-year rule is similar to the 5-year-rule, with no annual payments required.
Example: Paula, age 55, died in September 2022. Paula had named her daughter, Jessica, age 23, as the sole primary beneficiary of her Traditional IRA. Because Paula had died before her RBD, Jessica can wait until December 31, 2032, to distribute her entire inherited IRA balance.
Beneficiaries Provided Relief Under the new RMD Guidance
This relief is limited to distributions required to be made in 2021 or 2022 under the 10-year rule if
the account owner died on or after their RBD in 2020 or 2021, and
the designated beneficiary is not taking life expectancy payments.
The same 10-year rule relief also applies to a successor beneficiary of an eligible designated beneficiary if
the eligible designated beneficiary died in 2020 or 2021, and
that eligible designated beneficiary was taking life expectancy payments.
Example: Kevin, age 76, died in July 2020. Kevin’s son, Marcus, age 49, is the sole primary beneficiary of Kevin’s Traditional IRA. Marcus is subject to the 10-year rule and has until December 31, 2030, to distribute his entire inherited IRA. When the proposed RMD regulations were released in February 2022, Marcus learned that he was required to take annual payments for the first nine years (based on his single life expectancy, nonrecalculated), and then distribute the remaining balance in the tenth year. Marcus realizes that he unintentionally missed his 2021 payment and is required to take another payment by the end of 2022. Normally, Marcus would owe a 50 percent penalty tax on the undistributed 2021 payment, but Notice 2022-53 waives this penalty tax for 2021 and for 2022.
In addition to waiving the 50 percent excess accumulation penalty tax, the Notice states that defined contribution plans that failed to make a required payment will not be treated as having an operational failure as a result of failing to satisfy the RMD requirements.
What’s Next?
This guidance provides plan sponsors and beneficiaries with specified RMD relief for 2021 and 2022 while the IRS finalizes its RMD rule for the 2023 distribution year. The guidance does not, however, provide additional guidance on the status of the rest of the proposed RMD rules for the 2022 distribution year.
The preamble of the proposed RMD regulations indicates that taxpayers must apply the existing regulations and exercise a “reasonable, good faith interpretation” of the SECURE Act’s 10-year rule and increased RMD age for 2021. Compliance with the proposed regulations will satisfy that requirement. But neither the proposed rule nor the Notice state whether such reasonable, good faith interpretation can be applied for 2022.
If your clients are unsure whether they should take a life expectancy payment this year in light of Notice 2022-53 and the proposed RMD regulations, they should consider seeking competent tax advice before making a decision.
