Treasury Solidifies Retirement Plan Distribution Rules

By Connor Smart July 25, 2024

On July 18, 2024, the Department of the Treasury and the Internal Revenue Service issued final regulations updating the required minimum distribution (RMD) rules. The Treasury press release may be found here, and full final regulations can be found online on the Federal Register here.

Occasionally, tax bills or regulations will come out that significantly change the tax landscape; that create a paradigm shift in how US and global citizens are to comply with the minutiae of US tax law – these final regulations are not so dramatic. Rather, these final RMD Regulations clarify – but largely retain – the rules and guidance set forth in the proposed RMD regulations issued in 2022, and in many cases reference and retain preexisting definitions dating as far back as 2002. To quote Treasury directly: “While certain changes were made in response to comments received on the proposed regulations issued in 2022, the final regulations generally follow those proposed regulations.”

That said, while these Final Regulations largely retain the guidance put forth in the proposed regulations issued a few years ago, their publication offers us a chance to review and reconsider the RMD rules, and to proceed knowing that this latest publication is the effective and definitive ruleset.

First, to really discuss and summarize the final regulations, establishing some definitions and background may be useful.

Basic RMD definitions

RMDs are the minimum amounts an individual must withdraw from their retirement account each year. Generally, upon reaching a certain age (specified in the regulations and dependent on birth year), a retirement plan account holder is required to start taking funds out of their plan. The amount to be annually distributed by the original employee or account holder is dependent on individual’s age and the value of their plan assets. While account holders may withdraw more than this minimum, failure to take distributions of at least the RMD value results in the assessment of excise taxes and penalties. Until 2023, the penalty for failure to take RMDs was as much as 50% on the distribution shortfall (this fell to 25% or, if timely corrected, 10%, starting in 2023).

The RMD rules apply to traditional IRA plans, SEP IRA, SIMPLE IRA, profit-sharing plans, 401(k) plans, 403(b) plans, and certain 457 plans. Treasury’s intent and purpose behind these rules is that, because such tax advantaged plans allow an individual to defer income on their retirement savings until late in life, the rules offer Treasury a way to recoup some of the tax on the plans’ accumulated income; while the plans allow deferral of income tax for many years, that deferral is not infinite.

Background and recent changes to RMD rules

The basic RMD rules were modified in 2019 under SECURE 1.0, along with many other retirement plan tax provisions (you can read our previous article summarizing SECURE 1.0 here). Under SECURE 1.0, the Act raised the age for RMDs from 70 ½ to 72, effective in 2020 and applicable to individuals born on or after July 1, 1949. Therefore, SECURE 1.0 allowed a plan account holder to enjoy longer tax-deferred growth. However, SECURE 1.0 allowed Treasury to recoup the funding related to that deferral by altering the treatment of beneficiaries of such plans.

Historically, non-spouses who inherited IRA accounts could take distributions (RMDs) over their life expectancies. So, for example, an individual who passed on their IRA to a grandchild upon death could significantly delay distributions out of the plan. SECURE 1.0 ended such “stretch IRA” planning, and now generally requires that all distributions from IRAs inherited by non-spouses be paid out within 10 years.

Then, a couple of years later, SECURE 2.0 was passed in late December 2022. SECURE 2.0 made the following significant changes to the RMD rules (you can read our full synopsis of SECURE 2.0 and its many other facets here):

1. SECURE 2.0 further increased the RMD age up to 73 for a person who reaches age 72 after December 31, 2022; and up to age 75 for a person who reaches age 74 after December 31, 2032.
2. SECURE 2.0 reduced the penalty for failure to take RMDs from a 50% excise tax down to 25%. Additionally, if the failed or missed RMD is corrected and fully take within a two-year correction window, that 25% penalty can be dropped down to 10%, or even abated entirely if the failure was due to reasonable cause.

Accordingly, SECURE 2.0 allowed for further deferral of income for retirement plan holders and reduced the risk and penalties of failure to comply with the RMD rules.

However, SECURE 2.0 did nothing to change the timeline for beneficiary-RMDs, or the interplay between an old 5-year rule, the new 10-year rule, or life expectancy distribution timelines. Such nuances were first addressed by the IRS in 2022 under the proposed RMD rules issued subsequent to the SECURE act and which have now been solidified under the final regulations.

Impact and summary of final RMD regulations

As is frequently the case with tax publications, these final regulations are quite long (about 260 pages in total), but most taxpayers will find only certain sub-sections to ever be of relevance to them personally. Accordingly, the following is not meant to be all-inclusive of the final regulations – rather, the summary below is meant to cover those sections of the final regulations most likely to be applicable to the general taxpayer.

10-year beneficiary distribution rule

The most “controversial” and significant part of the final regulations is the clarification for the 10-year distribution rule. To simplify, the 10-Year Rule stipulates that beneficiaries of a retirement plan that is subject to RMDs are required to fully distribute the plan’s assets within 10 years of inheriting the plan, with limited exceptions.

When the IRS previously issued the RMD proposed regulations, there was confusion on how the timing for this 10-year rule should be followed in practice: does this rule mean that a beneficiary can postpone all distributions for 9 years, then take the full balance in year 10? Or is the beneficiary required to take annual distributions through the 10 years?

The Final Regulations note that the answer here lies in Section 401(a)(9)(B)(i), which provides that “if an employee dies after distributions [RMDs] have begun, the employee’s remaining interest must be distributed at least as rapidly under the distribution method…as of the date of death.” This “at least as rapidly rule” was not subverted or changed by SECURE 1.0 or SECURE 2.0, and the IRS has retained this rule in the Final Regulations.

This means that, should a beneficiary inherit a plan after the original owner became subject to RMDs, they must continue to make distributions to ensure the plan is paid out “at least as rapidly” as if the original RMDs continued with the original account owner, but have 10 years to fully distribute the plan. To correctly apply this rule, beneficiaries must follow two steps:

1. They must take annual distributions out of the inherited plan at the very least following the original account holder’s life expectancy payout timeline, and
2. They must take whatever balance remains as a distribution in year 10 following the year of death.

Note that this annual distribution rule applies only if RMDs had already begun when the original account holder died. If death occurs before the RMD’s required beginning date, the beneficiary is still generally required to distribute the full balance of the inherited plan by the tenth anniversary of the date of death, but annual distributions are not required (all can be taken in year ten).

As there was much confusion regarding the application of this new 10-year rule, the IRS has been regularly and continually postponing the applicable penalties and excise taxes on failures to take RMDs. Now that the Final Regulations have been issued, such postponement has ended, and the IRS will once again begin assessing the failure to take RMD excise tax on beneficiaries. Designated beneficiaries who were not taking annual distributions in accordance with the 10-year rule were granted automatic relief through 2024. Accordingly, plan beneficiaries subject to these rules should intend to start taking distributions in 2025, less they be subject to excise taxes and penalties.

Eligible designated beneficiaries

In the text above I noted that there were “limited exceptions” to this 10-year distribution rule. The biggest exception is the “eligible designated beneficiaries” rule. This rule allows special types of beneficiaries of an inherited plan to continue to take RMDs using the life expectancy timeline, as was the case pre-SECURE Act under the old rules, as opposed to the potentially accelerated new 10-year rules and timeline.

To be an eligible designated beneficiary, an individual must be one of the following:

1. The surviving spouse of the original account holder.
2. A child of the employee who has not yet reached the age of majority.*
3. Disabled, as defined by the final regulations.
4. Chronically ill, as defined by the final regulations.
5. Not more than 10 years younger than the employee.

*The final regulations stipulate that the age of majority is 21. Once a child-beneficiary reaches the age of majority, they default back to the 10-year rule. Effectively, this means that if an account holder leaves their plan to their minor child, the full value of that plan will need to be distributed by the time the child reaches age 31.

Also note that these exceptions may become voided if a plan has multiple beneficiaries – if there is more than one beneficiary, and at least one of those beneficiaries does not fit within one of the eligible designated beneficiary classifications noted above, then the plan is treated as not having any eligible designated beneficiaries, and every inheritor is subject to the 10-year rule. Additionally, beneficiaries of the account holder’s original beneficiaries are also subject to the 10-year rule, regardless of if they are inheriting the plan from an eligible designated beneficiary.

For example, if the first, sole beneficiary is an eligible designated beneficiary (say the original account holder’s spouse), and that spouse then passes the plan on to their child upon their death, that child may be a designated beneficiary, but they would not be an “eligible” designated beneficiary, and therefore would be subject to the 10-year rule; they would need to fully distribute the plan’s assets by the 10^th anniversary of the original eligible designated beneficiary’s death.

Regardless of whether a beneficiary is deemed an “eligible” beneficiary or not, taxpayers should be aware that a beneficiary needs to be designated no later than September 30 of the year following the year of death. Accordingly, for tax planning purposes, having proper beneficiaries documented and elected ahead of time is critical.

Lastly, note that regardless of whether someone is an “eligible” beneficiary or not, the account value used to determine the RMD is the account balance as of the last valuation date in the prior calendar year (excluding the balance of Roth accounts not subject to the RMD rules).

Rollovers and charitable distributions

The Final Regulations explain that qualified charitable distributions out of a plan subject to RMDs can be used to satisfy the annual RMD requirements (up to $100,000). Such is retained from prior rules and regulations.

Similarly, the Final Regulations go into detail describing that rollovers of account balances do not satisfy the annual RMD requirements. The bottom line here is that moving plan assets in and out of various accounts does not negate the requirement to annually recognize as income a distribution from the plan, inherited or otherwise, as calculated and pursuant to the timeline mandated by the final regulations (i.e., 10-year rule or life-expectancy).

Other miscellaneous matters discussed in the final regulations

As noted, this article is not meant to be all-inclusive of the final regulations. However, readers may want to be aware of some other information contained in the final regulations:

1. The final regulations outline separate RMD rules for beneficiaries that are trusts. To oversimplify, if the trust is established as a proper look-through trust, it is possible for the beneficiaries of the trust to retain and follow the RMD rules as if they were direct beneficiaries of the plan.
2. The Final RMD Regulations described above largely do not apply if the plan in question is a defined benefit plan; such plans have their own specific and complex rules.
3. Most of the information discussed above applies to non-Roth accounts. Roth accounts have their own separate rules and generally are not subject to RMDs in the same manner as are non-Roth accounts. For example, the rules requiring RMDs to be paid during an original account holder’s lifetime do not apply to designated Roth accounts. Therefore, if an employee’s interest under a plan is in a designated Roth account, then no distributions are required to be made during their lifetime, and that employee, upon death, is treated as having died before any RMD required beginning date. Most of the Final Regulations apply to plans that are not Roth plans.

Conclusion

Between these final RMD regulations and the two SECURE tax acts, taxpayers have become subject to hundreds of pages of new tax compliance standards in only a few short years (while, simultaneously, dealing with other tax and accounting upheaval through the Pandemic). While this article covers some of the more significant aspects of these standards specific to RMDs, the total content covered in these publications is vast, and the nuances are complex. As the proper application and practice of these regulations is highly facts-and-circumstances specific, taxpayers impacted by any of these provisions should seek qualified professional assistance before arriving at any final position or treatment.

For more information, please contact Connor Smart or your BNN tax advisor at 800.244.7444.