(Lexology) - The Setting Every Community Up for Retirement Enhancement Act (“SECURE Act”), which went into effect on January 1, 2020, made significant changes to the laws governing IRAs and other retirement plans. In particular, the SECURE Act affected the required beginning date of participants or the date on which participants must begin taking annual required minimum distributions (RMDs). The SECURE Act also impacted beneficiaries’ income tax deferral benefits on inherited IRAs.
The IRS issued Proposed Regulations in February 2022 that upset and directly contradicted the well-accepted assumptions that practitioners had developed over the past two years. As a result, most IRA beneficiaries are now facing even less favorable income tax deferral than expected.
Changes to Deferral Options for Individual IRA Beneficiaries
The SECURE Act did not change the deferral options for surviving spouses. The Act did limit the ability of most other individual beneficiaries to “stretch-out” IRA distributions over their lifetimes, as they could before the Act’s passage. Only “eligible designated beneficiaries” can stretch-out IRA distributions over their lifetimes; eligible designated beneficiaries include:
Disabled or chronically ill beneficiaries; and
Beneficiaries who are not in any of the above categories and are not more than ten years younger than the participants.
Individuals who do not qualify as “eligible designated beneficiaries” are subject to a deferral limit. More specifically, these beneficiaries must withdraw all the assets in the inherited IRA by the end of the tenth year following the year of the participant’s death and pay any income taxes associated with those withdrawals.
Non-Individual IRA Beneficiaries
Under the SECURE Act, non-individual beneficiaries remain subject to an even more stringent deferral limit. These beneficiaries have a five-year deferral limit, meaning they must withdraw all the assets in the inherited IRA by the end of the fifth year following the year of the participant’s death and pay any resulting income tax liability.
The Effect of the IRS Proposed Regulations on the 10-Year Deferral Rule
The IRS Proposed Regulations undercut one of the basic assumptions of the ten-year deferral rule – that the beneficiary need not take annual RMDs during the ten-year deferral period. Before the SECURE Act, non-individual beneficiaries did not have to take annual RMDs during the five-year deferral period, which led to the same assumption for the ten-year deferral period for individuals who did not qualify as eligible designated beneficiaries.
The IRS Proposed Regulations reach the opposite conclusion. In other words, if the IRA participant died after their required beginning date, which is currently April 1st of the year after the participant turns seventy-two, beneficiaries subject to five or ten-year deferral periods also must take an annual RMD. The amount of the annual RMD is based on the beneficiary’s remaining life expectancy, even though the beneficiary can no longer stretch-out the withdrawal of the IRA assets over their life expectancy.
The other issue that the IRS Proposed Regulations do not address is how beneficiaries are to address missed RMDs for 2021 when beneficiaries were operating under the assumption that annual RMDs were not required. At this point, it is unclear how the IRS will treat any missed RMDs, or how one should remedy any missed RMDs; experienced ERISA counsel can help determine the appropriate course of action.