Many investors are familiar with the long-standing requirement to take a minimum distribution (RMD) from most tax deferred retirement accounts beginning at 70.5 years of age. However, in recent years there have been changes to the RMD rules and on February 24, 2022, the Internal Revenue Service (IRS) issued proposed new regulations that, if enacted, will result in additional rule changes.
a. Which Investment Accounts Are Subject To RMD Rules?
Most tax deferred retirement accounts are subject to the RMD rules. These accounts include traditional IRA’s, SEP IRA’s, SIMPLE IRA’s, 401(k) plans, 403(b) plans, 457(b) plans, and profit-sharing plans. Although an RMD is not required to be taken from a Roth IRA while the account holder is alive, an RMD must be taken from a Roth 401(k).
b. At What Age Must RMD begin?
Prior to the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), account holders were required to start taking withdrawals from an RMD eligible plan upon reaching age 70.5. If the account holder reached age 70.5 in 2019, he/she was required to take the first RMD on or before April 1, 2020. However, the changes to the RMD rules enacted under the SECURE Act extended the deadline to age 72. If the account holder turned age 70.5 in 2020 or after, he/she was required to take the first RMD on or before April 1 of the year after he/she reached age 72. After the account holder takes the first RMD, subsequent RMD’s must be taken on or before December 31 of each year.
On March 29, 2022, the U.S. House of Representatives passed the Securing a Strong Retirement Act, dubbed SECURE Act 2.0. This bill is now under consideration in the Senate. SECURE Act 2.0 proposes increasing the age to begin taking RMD’s. Specifically, it is proposed that the commencement age would be increased to age 73 in 2022, age 74 in 2029, and age 75 in 2032.
c. What Is The Penalty If An RMD Is Not Taken?
The penalty for failure to take an RMD is very punitive. Under current law the penalty for missing an RMD is 50% of the amount of the RMD that was due. In the event of a missed RMD, the account holder may petition the IRS for relief if he/she can show the missed RMD was the result of a reasonable error and that he/she took reasonable steps to remedy the shortfall.
On February 24, 2022, the IRS issued proposed regulations that would create additional rule changes related to RMD’s. Among these rule changes would be two circumstances under which the IRS would waive the 50% penalty for a missed RMD. These penalty waivers may apply in the event of a missed RMD after the account holder’s death.
d. How Is An RMD Calculated?
To calculate the RMD, the account holder must start with the Uniform Lifetime Table. To determine the RMD for 2022, the account holder will divide the life expectancy factor for his/her age into his/her account balance as of December 31, 2021. In 2021, the IRS updated the Uniform Lifetime Table for the first time in nearly twenty years. The updated lifetime table increased life expectancy which, in turn, results in a lower RMD figure than calculated under the prior table. Lowering the amount of the RMD decreases tax liability and allows the account holder to keep more assets in a tax deferred account.
e. Calculation of RMD After Account Holder’s Death (Inherited Accounts)
After an account holder’s death, beneficiaries who inherit a tax deferred account, including a Roth IRA, are required to take RMD’s. The SECURE Act changed the rules for calculation of the RMD for deaths that occur after January 1, 2020. The rules vary based on three categories of beneficiary:
Eligible Designated Beneficiary: An EDB may calculate the RMD based on the EDB’s own life expectancy. EDB’s include the surviving spouse, child of the deceased who has not reached the age of majority, a disabled or chronically ill individual, and any individual who is less than ten years younger than the deceased account holder. Once a child of the deceased reaches the age of majority, he/she must follow the rules that apply to a Designated Beneficiary.
Designated Beneficiary: A DB is any named beneficiary that does not meet the definition of an EDB. A DB must distribute the account balance on or before December 31st of the tenth year following the account holder’s death. This is often referred to as the “ten-year rule”. Under current law, period distributions are not required on an annual basis and the beneficiary could take the entire account balance at any time during the ten-year period, including waiting until the deadline before taking a withdrawal. The IRS regulations proposed February 24, 2022 intend to change the ten- year rule to require annual periodic distributions. These proposed regulations are open for public comment until May 25, 2022 and have not yet been enacted.
Non-Designated Beneficiary: An NDB is generally regarded as the worst category of beneficiary for purposes of RMD calculation. An NDB is created when the account holder fails to designate a beneficiary (or fails to update a beneficiary form) and the account becomes part of an estate. A trust may also be considered an NDB if it does not meet the criteria to be regarded as a Designated Beneficiary. Charities are also regarded as an NDB. Calculation of the RMD for an NDB depends on whether the account holder died before or after RMD’s began during the account holder’s life. If the account holder died before RMD’s began, the entire balance of the account must be taken by the end of the fifth year following the account holder’s year of death. If the account holder died after RMD’s began, the beneficiary will continue to take periodic RMD payments but will reduce the beginning life expectancy of the deceased by 1 for each subsequent year in the RMD calculation.
The proposed IRS regulations changing the calculation to require periodic distributions have some concerned. There are many beneficiaries subject to the ten-year rule who have not taken a periodic RMD for an account holder who died after January 1, 2020. The concern is these beneficiaries may be subject to the steep 50% penalty for failure to take a periodic RMD if these rules are enacted. It is likely the IRS will address this concern in the final regulations.
The proposed regulations also attempt to clarify the SECURE Act rules. One example is defining the age of majority for a child of a deceased account holder to be 21 years of age. Another example is providing details and examples from private letter rulings that will assist in determining whether a trust will meet the definition of an Eligible Designated Beneficiary or a Designated Beneficiary to avoid being unintendedly classified as a Non-Designated Beneficiary.
EBS is not an accounting or law firm and the foregoing is a general summary of the rules and limitations that may apply to you. It is not intended to apply to all persons and situations and you should contact your tax or legal professional for advice. Please contact a member of the Wealth Management Group to discuss your specific situation.
Data provided has been obtained by third party sources. This data, while believed to be reliable, has not been independently verified by EBS.