The IRS has just released final regulations on required minimum distributions (RMDs) from qualified plans and traditional IRAs. The much-anticipated final regs provide guidance on tax law changes made by the Setting Every Community Up for Retirement Enhancement (SECURE) Act (enacted in 2019) and the SECURE 2.0 Act (enacted in 2022). The final rules about inherited accounts generally mirror what the IRS proposed in 2022. But there are several interesting twists and turns that you should be aware of.
Old Rules
Under long-standing rules, participants in qualified retirement plans — including 401(k) plans, 403(b) plans for not-for-profits, 457(b) plans for government entities, SEPs and SIMPLEs — as well as traditional IRAs are required to begin taking RMDs upon attaining a specified age.
Important: Roth IRA participants don't have to take RMDs, but this exception didn't apply to participants and beneficiaries of Roth 401(k) accounts.
RMDs are taxed at ordinary income tax rates. Currently, the top federal tax rate is 37%. The amount of each RMD is based on 1) life expectancy tables that were updated in 2022, and 2) the value of the account on December 31 of the prior year.
For decades, the required beginning date for qualified plan and IRA participants was April 1 of the year following the year in which you turned age 70½. For example, if you turned age 70 on January 1 of the current year, you were required to begin taking RMDs by April 1 of the following year. Then you had to keep taking RMDs for each succeeding tax year.
The IRS also imposed a hefty penalty for failing to take RMDs in a timely fashion. The penalty (before 2023) was equal to 50% of the RMD amount (or the difference between this amount and any RMD taken).
However, in a series of notices, the IRS waived penalties for failing to take RMDs from inherited accounts for the 2020 through 2023 tax years. The regular rules for RMDs for plan and IRA participants were revived in 2024.
2019 and 2022 Legislative Changes
The two major retirement planning laws enacted in recent years include several significant changes relating to RMDs. For starters, the SECURE Act increased the required beginning date of qualified plan and IRA participants from age 70½ to age 72, beginning in 2020. Then, SECURE 2.0 raised it again to age 73 beginning in 2023 (it is scheduled to increase to age 75 in 2033). So, if you turn age 73 in 2024, you must begin taking RMDs by April 1, 2025.
In addition, SECURE 2.0 cut the penalty for failing to take timely RMDs in half from 50% to 25% of the shortfall, beginning in 2023. Even better, the penalty drops to 10% for retirement account owners who promptly correct the error. The law also eliminated the requirement for Roth 401(k) participants to take RMDs, beginning in 2024.
Notably, with certain exceptions, the SECURE Act requires qualified plan and IRA beneficiaries to empty out an inherited account over a 10-year period, effective beginning in 2020. Prior to this change, beneficiaries could take out RMDs over life expectancy tables, further extending tax-deferred compounding of funds. This tax law provision effectively eliminated "stretch IRAs" that could extend tax deferral for generations.
However, certain "eligible designated beneficiaries" are exempt from the new 10-year requirement, including:
- The IRA participant's surviving spouse,
- The IRA participant's minor child,
- A disabled or chronically ill individual, and
- Any other individual who isn't more than 10 years younger than the IRA participant.
These beneficiaries have other favorable RMD options at their disposal. (However, once a child reaches the age of majority, they're no longer treated as an eligible designated beneficiary.)
Point of Contention
When the SECURE Act passed in 2019, it wasn't clear from the language of the law whether beneficiaries had to take out RMDs over the course of 10 years or if they could wait until the 10th year to take the full payout. The proposed regulations issued in 2022 provided that beneficiaries must take RMDs in years one through nine if the original account owner had died after reaching his or her required beginning date.
This was bad news for beneficiaries who didn't know they were required to take RMDs from accounts of those who died in 2020 or 2021. They could have been hit with the penalty on the RMD amounts that should have been withdrawn but weren't. Reacting to public comments, the IRS postponed the requirement — twice — until 2024. Now it has finally shed more light on the issue.
Highlights of the New Final Regs
The final regulations clarify that IRA beneficiaries must follow the 10-year sequencing rule as presented in the proposed regulations. Therefore, the IRS is "doubling down" on its interpretation of this SECURE Act provision. But it's waiving penalties for annual RMDs that were required by beneficiaries for the tax years before 2025.
For instance, suppose you inherited an IRA from your father who died in 2020 and he'd already started taking RMDs. Under the SECURE Act, you must empty out the IRA by 2030. The new final regs now require you to take RMDs based on your life expectancy for years one through nine. However, because of the waiver, you don't have to take any RMDs for tax years from 2021 to 2024.
Accordingly, your responsibility to take annual RMDs begins with tax year 2025. This practice must continue through tax year 2029. Note that the 10-year requirement doesn't change due to any waivers in prior years. If the original account owner died before his or her required beginning date (now referred to as the "applicable age"), the beneficiary has more leeway in timing RMDs, but still must empty the account within 10 years.
Additional Regs for All Account Holders
The IRS also issued proposed regs clarifying that the applicable RMD age for someone born in 1959 is age 73, addressing some ambiguity in the SECURE 2.0 law. Expect to hear soon from the IRS on this point.
In addition, the regs add even more complexity to the mix by implementing special rules for beneficiaries who inherit a decedent's Roth 401(k) if it constitutes the "entire plan balance." In this case, the account might have to be emptied out within 10 years, sooner than may have been expected.
Another change in the final regulations favors multiple beneficiaries of a single account. Previously, the RMD had to be divided proportionately based on the percentage of the account that was inherited. Beginning in 2025, the RMD can be divided in any way among multiple beneficiaries as long as the entire required amount is paid out each year.
What's Next?
The new final regs, which take effect on September 17, 2024, may raise as many questions as they provide answers. It will take a while to evaluate all the nuances of the 260-page guidance, and the IRS is likely to provide additional guidance. Also, Congress may decide to weigh in again on these matters. Consult your professional tax advisor for more information.