The recent proposed regulations (“regulations”) of the SECURE Act issued on February 23, 2022 surprised the tax community with rules regarding the 10 year distribution rule for beneficiaries, pleased the tax community by providing examples for determining whether “remote” beneficiaries of accumulation trusts are considered and left the tax community still questioning some areas. While this blog can not cover all the regulations, following are some of the highlights.
1. The most startling (in this author’s opinion) change relates to the requirement that an “ordinary” beneficiary (not an eligible designated beneficiary who can continue to use the life expectancy tables) take their distributions over 10 years. It was most experts’ opinion that there was NO requirement that the distributions be paid until the end of the 10th year after the death of the participant/owner of the IRA (the “owner”). However, the regulations differentiate between a designated beneficiary who dies before the employee’s required beginning date (“RBD”) and a designated beneficiary who dies after the RBD. The RBD is the date an owner MUST take minimum required distributions (“RMD”) from their individual retirement account (“IRA”). Currently, in most cases, the RBD is April 1st after the year turning age 72.
Example: Paul, age 65 (before his RBD), dies with a child, Sue, 35, who is named as a beneficiary of Paul’s IRA. Sue can take the distributions from Paul’s IRA anytime over the 10 years after Paul’s death. She could prorate it over 10 years, take it all in year 1, take it in different amounts in all the years or take it all in the 10th year after Paul’s death. In all events Sue MUST take it all by the 10th year after Paul’s death.
Example: Paul, age 74, dies after his RBD. Sue must take the RMDs over her life expectancy table from the year after Paul’s death and in the 10th year after Paul’s death must take the balance. She could take more in years 1-9 but she MUST take the RMD in years 1-9 and MUST empty the account in the 10th year after Paul’s death.
Some questions arise. Who is actually going to calculate the RMDs for the beneficiary who receives distributions from an owner who dies after his or her RBD? What happens to those beneficiaries who thought in 2020 or 2021 that they did not have to take a distribution until the 10th year after the employee participant’s death? Why does that matter? A 50% penalty applies for RMD’s that are not withdrawn.
As to the latter question, the regulations apply to distributions after January 1, 2022 . For 2020, taxpayers must comply with existing regulations and a reasonable good faith interpretation of the SECURE Act. So if your client took no RMD in 2021 for someone who died in 2020, you can do one of the following as recommended by a seminar at the annual meeting of the Employee Benefits Committee of the American College of Trust and Estate Counsel…
a. Wait until the end of 2022 and hope that the IRS waives any penalties for not taking distributions in 2021;
b. Do not withdraw RMD and, if audited, defend with the “reasonable good faith” interpretation of the SECURE ACT;
c. Do not withdraw RMD and file a Form 5329 showing 0 and start the statute of limitations; or
d. Withdraw the RMD late and file the Form 5329 and ask for the waiver of penalties.
2. The regulations clarify that the age of a minor (who can be an eligible designated beneficiary until the age of majority) is 21. There was much confusion as the age of majority is state to state specific. Further, an exception existed for certain minors who were in school until age 26 (this exception still applies to certain plans which specifically refer to this exception) which was difficult to to apply. Thus, a minor, once becoming age 21, must use the 10 year rule. Whether the minor must take RMDs immediately or can wait until the 10th year after the date of the owner’s death to take the balance depends on whether the owner died on or after the owner’s RBD.
Example: Nora who is age 45 dies with a minor child, Sue, who is 16. Nora dies prior to her RBD. Sue can take RMDs over her life expectancy until she reaches age 21. At age 21 Sue has the choice to take the distributions in any amount over 10 years or take it all in the 10th year after Nora’s death.
If Nora had reached her RBD, with a minor child (highly unlikely but not impossible), then, when the minor child reaches age 21, the minor child must continue to take RMDs over the child’s remaining life expectancy in each of the next 10 years and then, in the 10th year, take the balance. After age 21, the child can always take more than the RMD in any year but must withdraw all by the end of the 10th year after Nora’s death.
3.The regulations provide a safe harbor to determine whether an individual is disabled. Under the SECURE Act, a disabled beneficiary is an eligible designated beneficiary allowed to take RMDs over their life expectancy. These regulations provide that an individual will be disabled for purposes of the eligible designated beneficiary rule if the individual is “deemed” disabled by the Social Security Administration as of the date of the death of the owner. The disability has to exist AT THE DATE OF DEATH of the owner. If an individual becomes disabled after the date of death of the owner, then the individual is merely a designated beneficiary (subject to the 10 year rules) and not an eligible designated beneficiary permitted to use their life expectancy.
The regulations provide further rules on how to determine whether a person is disabled. Documentation of the disability must be provided to the IRA custodian by October 31 of the calendar year following the calendar year of the owner’s death.
4. The terms “accumulation trusts” and “conduit trusts”, while used extensively by practitioners, are now confirmed terms in the regulations. There are examples of whether a “remote” or contingent beneficiary must be “counted” to determine whether a “see-through” trust exists and whom are identifiable beneficiaries and which beneficiaries of the trust can be disregarded.
Example: IRA payable to a trust for the benefit of wife, if living, and if she dies prior to the payout of the IRA, then to brother, if then living and then to charity. The charity is a “secondary” beneficiary who can only inherit trust assets because of the death of another secondary beneficiary, brother. The charity is not counted and would not cause the “see-through” trust to fail. The first secondary beneficiary, brother, MUST survive the owner.
ADVICE: If these regulations seem difficult, do not feel alone. They are very difficult. The preamble to the regulations is a MUST reading for anyone advising in this area. Many more items are covered, such as powers of appointment (favorable), permission of modifications of trust under state law without violating the “see-through” trust rules (favorable), chronically ill definitions and much more. Keep an eye out for seminars on the regulations as this area of law is a very complex area and one that is ripe for malpractice through incorrect advice. If practicing in this area, Natalie Choate’s book (available in print or online), which will be updated for these proposed regulations, is a MUST. Remember that these regulations are PROPOSED regulations. Comments must be provided to the Internal Revenue Service by May 25, 2022 and a public hearing will be held June 15, 2022. Further, if a reader sees any mistakes in the blog please notify the author and a new blog with clarifications will be posted. Please also understand that the author did not cover ALL regulations.
WORD OF THE WEEK: Applicable denominator is a new term provided in the regulations. The former term, “applicable distribution period”, is the time period over which benefits must be distributed under the RMD rules. For example, Paul, age 73, dies and he has an named a disabled individual, Tom, age 34, as a beneficiary. Because Tom is an eligible designated beneficiary (assuming the proper documentation is provided to the custodian by October 31st of the year following Paul’s death), Tom can use his life expectancy for determining RMDs. Thus, if Tom is 35 in the year after Paul’s death, he would review the new 2022 single life expectancy table and find that his life expectancy is 50.5. If the amount in Paul’s IRA is $200,000, Tom would divide $200,000 by 50.5 the applicable denominator (formerly called the applicable distribution period) and the RMD would be $3,960.39 in the first year after Paul’s death. Each year thereafter, the applicable denominator will be 50.5 less 1 (in year 2), then less 2 (in year 3), then less 3 (in year 4), etc.
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