On July 19, 2024, the Internal Revenue Service released its long-awaited final regulations on required minimum distributions for individual retirement accounts and employer plans. Two of the key rules addressed in these regulations are whether a designated beneficiary must take annual RMDs and whether such a beneficiary can get an extension on the 10-year deadline. With the explanations, it’s now settled that certain 10-year beneficiaries must take annual RMDs and don’t get an extension on their 10-year deadline.
How We Got Here
The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), enacted on Dec. 20, 2019, as Division O of the Further Consolidated Appropriations Act, 2020, Public Law 116-94, 133 Stat. 2534 (2019), changed the options available to beneficiaries who inherit IRAs and employer plan accounts (retirement accounts) after 2019. One of the most significant changes required designated beneficiaries and certain successor beneficiaries to distribute accounts they inherit within 10 years. Previously, designated and successor beneficiaries could take distributions over the entire length of the designated beneficiary’s applicable life expectancy.
Before the SECURE Act was enacted, a 5-year rule applied when the IRA owner or plan participant died before their required beginning date (RBD). This rule required beneficiaries to distribute all assets in the IRA by the fifth year following the year in which the participant died.
The SECURE Act language for the new 10-year rule states:
In the case of a defined contribution plan, if an employee dies before the distribution of the employee’s entire interest—
“(i) IN GENERAL.—Except in the case of a beneficiary who is not a designated beneficiary, subparagraph (B)(ii)—
“(I) shall be applied by substituting ‘10 years’ for ‘5 years’, and
“(II) shall apply whether or not distributions of the employee’s interests have begun in accordance with subparagraph (A).
This language signaled that beneficiaries subject to the 10-year rule had the option of not taking distributions until the 10th year following the participant’s death. They must fully distribute the account at that time. As the language indicated, this applies regardless of whether the participant died before their RBD.
ALAR Rule
The proposed regulations (87 FR 10504) to these final regs included a reminder that the SECURE Act didn’t repeal the “at least as rapidly rule” (ALAR). As a result, any beneficiary who inherits a retirement account from an owner who was already required to start taking RMDs must continue to take distributions at least as rapidly as the rate at which the participant was taking distributions. Because the only life expectancy table that can be used to calculate RMDs for a beneficiary account is a Single Life Table, under the ALAR rule, beneficiaries must continue taking distributions and calculate them using the Single Life Expectancy table.
Designated beneficiaries who are now subject to the 10-year rule aren’t excluded from this ALAR provision. This means that a designated beneficiary who inherits a retirement account after 2019 from someone who died on or after the RBD must take annual RMDs. These annual RMDs would be calculated over the designated beneficiaries’ single life expectancy and are required to begin no later than the year following the year the participant dies.
This requirement to continue taking annual RMDs also applies to successor beneficiaries who inherit retirement accounts from eligible designated beneficiaries taking life expectancy distributions. For this purpose, eligible designated beneficiaries include designated beneficiaries who inherited retirement accounts before 2020.
The IRS received many complaints in response to the ALAR. Most stated that some of these beneficiaries didn’t take RMDs because they didn’t think they had to. Now, those beneficiaries would have to pay a 50% excise tax (reduced to 25% as of 2023) on RMDs that they didn’t take due to being misled by the language in the SECURE Act.
Automatic Waiver of the Excise Tax
In response to the complaints, the IRS issued Notice 2022-53, Notice 2023-54, and Notice 2024-35, which provide that the excise tax is automatically waived for affected beneficiaries who inherited retirement accounts from 2020 through to 2023 and didn’t take their RMDs from 2021 through 2024. These beneficiaries don’t have to file the required IRS Form 5329 to request a waiver of the excise tax.
As indicated in Notice 2024-35, the automatic waiver ends in 2024. Therefore, these beneficiaries must take RMDs due in 2025 and after or be subject to a 25% excise tax on any RMD shortfall.
Taxpayers wanted to know if the 10-year period was extended as a result of these waivers. The proposed regulations confirmed that it wasn’t. Therefore, a beneficiary who inherited a retirement account in 2021, for instance, must take annual RMDs and fully distribute the account no later than 2031.
Affected Beneficiaries
The 10-year rule applies to four classes of post-2019 beneficiaries.
- A designated beneficiary who inherits a retirement account from an owner who died before their RBD, which is April 1 of the year that follows the year of their first RMD. In this case, distributions are optional until the 10th year, when any remaining balance must be fully distributed.
- An eligible designated beneficiary who inherits a retirement account from someone who died before the RBD. Here, too, distributions are optional until the 10th year, when the account must be fully distributed. An eligible designated beneficiary may choose between this 10-year rule and the life expectancy rule under which distributions could be taken over the full length of their life expectancy.
- A designated beneficiary who inherits a retirement account from a participant who died on or after their RBD. In this case, the designated beneficiary must take annual distributions over their life expectancy and empty the account by the 10th year following the year the account owner died.
- A successor beneficiary who inherits a retirement account from an eligible designated beneficiary who was taking life expectancy distributions. The successor beneficiary must continue taking distributions at the same rate as the primary beneficiary. In addition, the successor beneficiary must ensure the account is fully distributed by the 10th year following the year the eligible designated beneficiary died.
The annual RMD requirement and the automatic waiver of the excise tax impact beneficiaries listed in numbers three and four.
What’s Next for These Beneficiaries?
The automatic excise tax waiver is a welcome solution for affected beneficiaries who failed to take their RMDs for 2021 through 2024. However, these beneficiaries must ensure that any RMDs required for 2025 are taken by Dec. 31, 2025. Missing this deadline will mean they owe the IRS a 25% excise tax on any RMD shortfall. If they miss the deadline due to reasonable error, their tax preparer may file IRS Form 5329 and request a waiver of the excise tax.
Beneficiaries should also consider the tax impact of bunching up distributions in a shorter time frame. For example, a beneficiary who inherited a retirement account in 2020 and didn’t take any distributions until 2025 has only six years to distribute the account. If the amount is significant, it could have an adverse tax impact on taxable distributions. However, the opposite might be true for some beneficiaries as there might be times when it’s tax-efficient to minimize distributions from their retirement accounts. Beneficiaries should consult with their tax advisor about when to take distributions and how much to take each year to increase tax efficiency.
