Retirement has always required difficult choices and prudent planning. A myriad of regulatory changes and emergency legislation passed to address the coronavirus (COVID-19) pandemic has led to confusion and uncertainty when it comes to the timing and calculation of required minimum distributions for retirement accounts. The changes are complex and regulations are still pending for many issues, so CPAs must stay alert and consider how the details may affect individual circumstances.
On November 12, 2020, the Treasury Department finalized proposed regulations regarding life expectancy tables that were originally issued in late 2019 [see Treasury Regulations section 1.401(a)(9)-9; see also Proposed Treasury Regulations section 1.401(a)(9)-9)]. In the interim, the COVID-19 pandemic and a myriad of legislative changes have created a legal hodgepodge that substantially altered the timing and calculation of required minimum distributions (RMD). As a result, calculating the appropriate RMD amount in 2021 and 2022 will be more challenging for taxpayers and tax practitioners.
This article provides an update to the authors’ June 2018 CPA Journal article, “Untangling the Inherited IRA Rules: Retiring Baby Boomers and the Impending Transfer of Wealth.” The previous article provided an overview of the mechanics of RMDs for traditional IRAs in light of the impending wealth transfer from the baby-boomer generation. But the COVID-19 pandemic along with the increasing costs and shortages associated with long-term care have created a difficult financial environment for seniors [Sean Fleming, World Economic Forum, “How COVID-19 Has Exposed the Challenges Facing the Care Sector” (Aug. 17, 2020); Organization for Economic Cooperation & Development, “Who Cares? Attracting and Retaining Care Workers for the Elderly” (June 22, 2020)]. Therefore, it will be imperative that baby boomers deploy retirement funds efficiently and that they avoid penalties for missed or under-withdrawn RMDs. Tax professionals with this clientele will need to be acutely aware of these changes.
The new RMD rules are still relatively straightforward. However, the recent changes present the following questions:
- How will the changes affect IRA owners?
- How will these changes affect beneficiaries?
- How will the 2020 RMD waiver affect initial RMDs for those turning 70½ or 72 in 2019 and 2020?
- What is the RMD required beginning date for those turning 70½ or 72 in 2019 and 2020?
- How will the 2020 RMD waiver affect the calculation of RMDs in future tax years?
Tax professionals should advise clients to choose their beneficiaries carefully, as eligible designated beneficiaries generally receive the most favorable tax treatment; however, certain categories of eligible designated beneficiaries have special limitations.
This article will first provide an overview of the changes to the RMD and beneficiary rules. The article will then detail the recalculation of RMDs starting in 2021, and conclude with a discussion of the changes in the life expectancy tables.
Required Minimum Distributions and Required Beginning Dates
Under Internal Revenue Code (IRC) section 401(a)(9), IRA owners must begin taking RMDs by their required beginning date. Originally, the required beginning date was April 1 of the year following the owner’s 70½ birthday (see Further Consolidated Appropriations Act of 2020, PL 116-94, section 114). The Secure (Setting Every Community Up for Retirement Enhancement) Act extends this age to 72; thus, taxpayers turning 70½ in 2020 have not yet reached their required beginning date. (Note: there is no maximum amount that owners above age 59½ may withdraw, and there is no penalty for withdrawal [IRC section 72(t)(2)(A)(ii)]). These rules simply ensure that funds are subject to eventual taxation through annual withdrawals. Owners should be aware of the 50% penalty for missed or under-withdrawn RMDs [Treasury Regulations sections 54.4974-1(a)-(b) and 1.408-2(b)(6)(v)]. The Coronavirus Aid, Relief, and Economic Security (CARES) Act forgave RMDs due for the 2020 tax year [IRC section 401(a) (9)(I)]. Therefore, as discussed below, owners are generally not required to make RMD withdrawals in 2020.
Categories and Special Classes of Beneficiaries
Under the prior rules, the only distinctions between beneficiaries were whether each beneficiary was designated and whether the beneficiary was a spouse [see prior IRC section 401(a) (9)(A), (B)(i-iv)]. Designated beneficiaries were generally accorded the most favorable tax treatment among nonspousal beneficiaries [see prior IRC section 401(a)(9)(B)]. An individual is designated when the account owner selects her as the beneficiary on record with the custodian/trustee [IRC section 401(a)(9)(E), Treasury Regulations section 1.401(a)(9)–4(A-1)]. A beneficiary is generally nondesignated if she is not listed on file with the custodian/trustee on the decedent’s date of death.
The Secure Act created the new eligible designated beneficiary category and limited IRA “stretching.” Stretching involves deferring IRA income tax liabilities by leaving the assets to relatively young beneficiaries to extend RMD withdrawals based on their longer life expectancy. These young beneficiaries could then pass the IRA to members of subsequent generations. IRA owners and their beneficiaries could potentially defer paying significant taxes on IRA funds for several decades. The new rules prevent stretching by creating an eligible designated beneficiary category and limiting the tax benefits of ineligible designated beneficiaries. In addition, the Secure Act creates restrictions on the type of distribution method available when a beneficiary of an inherited IRA dies.
The rules for nondesignated beneficiaries have not changed significantly. The amount of RMD will depend on whether the decedent began taking RMDs during his lifetime [IRC section 401(a)(9)(A) & (B)(i-iii)]. If the decedent already began taking RMDs, his remaining life expectancy is used to determine the beneficiary’s distribution period [Treasury Regulations section 1.401(a)(9)-5(A-5)(a)(2)]; if he had not begun taking RMDs, then the beneficiary would be required to withdraw all funds from the account by the end of the year containing the 5th anniversary of his death [IRC section 401(a)(9)(A), (B)(i-iii); Treasury Regulations section 1.401(a)(9)-3(A-4)(a)(2)].
Unlike nondesignated beneficiaries, the rules for designated beneficiaries have changed substantially. Under the Secure Act, designated beneficiaries are now required to follow a “10-year rule” [IRC section 401(a)(9)(H)(i)(I)]. The act substitutes a new 10-year rule for the old 5-year rule that required a beneficiary to withdraw all funds from an inherited IRA by December 31 of the year containing the 5th anniversary of the decedent’s date of death [Treasury Regulations section 1.401(a)(9)-3(b) (A-2)]. Presumably, any potential new regulations will require a designated beneficiary to withdraw all funds from the inherited IRA by December 31 of the year containing the 10th anniversary of the decedent’s date of death. Generally, this rule applies whether or not the decedent has begun taking RMDs [Treasury Regulations section 1.401(a)(9)-3]. But there is an exception, discussed below, for designated beneficiaries that are considered “eligible.”
Nonspousal Eligible Designated Beneficiaries
Eligible designated beneficiaries generally enjoy the most advantageous nonspousal RMD category. Eligible designated beneficiaries are allowed to select either the 10-year rule or lifetime rule (explained below) after the employee’s death [IRC section 401(a) (9)(E)(i), (ii) (2020); see also IRC section 401(a)(9)(H)(i-iii) (2020) and H.R. Rept. No. 116-65, at 108-109 (2019) for the exception for eligible designated beneficiaries].
The lifetime rule allows eligible designated beneficiaries to withdraw funds from the account over their remaining life expectancy. For this purpose, an eligible designated beneficiary is 1) a surviving spouse of the employee, 2) a minor child of the employee, 3) an individual with disabilities, 4) a person with a chronic illness, or 5) anyone not more than 10 years younger than the employee [IRC 401(a)(9)(E)(i), (ii)]. (The rules for spouses are detailed in the next section; the rules for all other categories are discussed below.)
Tax professionals should advise clients to choose their beneficiaries carefully, as eligible designated beneficiaries generally receive the most favorable tax treatment; however, certain categories of eligible designated beneficiaries have special limitations. For instance, children of the IRA owner will only qualify as eligible designated beneficiaries if they are under the age of majority [IRC 401(a)(9)(E)(iii)]. In addition, children lose their status as eligible designated beneficiaries upon reaching the age of majority and must withdraw all funds from the account 10 years after this date. [Note that the age of majority is 18 years old in most states, such as New York and New Jersey; among the exceptions are Alabama and Nebraska (age 19), and Mississippi (age 21).] Current rules do not set the specific age of majority to be used for this provision; therefore, the IRS may issue regulatory updates in the future setting the age of majority or exceptions thereof.
In general, eligible designated beneficiaries must follow the 10-year rule if they receive a previously inherited IRA.
A chronically ill eligible designated beneficiary is an individual who has received a certification from a licensed healthcare professional that she: 1) is unable to perform at least two activities of daily living, 2) has a disability that renders her unable to perform at least two activities of daily living, or 3) requires supervision due to cognitive defects [IRC sections 401(a)(9)(E) (ii)(IV) and 7702B(c)(2)]. Note that the certification for individuals falling within the first category of “chronically ill” must also state that the illness is either indefinite or lengthy in nature.
Under the new rules, an individual with disabilities qualifies as an eligible designated beneficiary [IRC sections 401(a)(9)(E)(ii)(III) and 72(m)(7)]. An individual is considered disabled under the new provisions if he is unable to participate in “gainful activities” due to a physical or mental impairment that has been medically determined.
In the case of an individual who is not 10 years younger than the deceased IRA owner, the beneficiary is not required to fall in any of the aforementioned categories [IRC section 401(a)(9)(E)(V)]. In addition, the beneficiary does not need to be related to the taxpayer.
Professionals should also note that the regulations for IRC section 401(a) (9) have not been updated to reflect when beneficiaries are required to make an election for the application of the 10-year rule and the life expectancy rule. Under prior law, nonspousal beneficiaries were required to make an election by December 31 of the year that the beneficiary is required to take the first life expectancy payment or 5-year payment, whichever comes first [Treasury Regulations section 1.401(a) (9)-3(A-4)(c)]. Therefore, advisors should discuss the timing of election options for inherited IRAs with clients.
Special Rules for Designated Spousal Beneficiaries
Spouses receive substantially similar tax treatment under both the old and new rules. Designated beneficiary spouses may choose between three options: 1) treat the account as their own [Treasury Regulations section 1.408-8(A-5)(a)], 2) roll over the funds [IRC section 402(c)(9) (2020) and Treasury Regulations section 1.402(c)-2(A-12) (a)], or 3) treat themselves as a non-spouse beneficiary [IRC section 401(a) (9)(B)(iv) (2020)]. However, tax advisors will need to be particularly careful when applying the old regulations, as they are not yet specifically tailored to the new Secure Act provisions. In addition, professionals may find it helpful to closely follow the timing of elections and RMDs required of spouses until new regulations are promulgated.
What Happens if a Beneficiary of an Inherited IRA Dies?
In general, eligible designated beneficiaries must follow the 10-year rule if they receive a previously inherited IRA [IRC section 401(a)(9)(H)(iii)]. The 10-year rule applies even if the beneficiary would normally qualify as an eligible designated beneficiary that could elect the life expectancy distribution method. Simply put, there is no option for the lifetime rule for previously inherited IRAs. Presumably, a surviving spouse may help her potential eligible beneficiaries avoid this result by electing to treat the deceased spouse’s account as her own; however, tax professionals will need to confirm this with supplementary regulatory and administrative tax guidance.
Avoiding RMD Pitfalls Due to the CARES Act RMD Waiver
Under the CARES Act (section 2203; IRC section 401(a)(9)(I)], RMDs due during 2020 are suspended for IRAs. This suspension does not, however, change a participant’s required beginning date (IRS Notice 2020-51). Taxpayers triggering their required beginning date will potentially have an RMD that straddles two separate tax years. An IRA owner’s initial calendar-year RMD distribution is delayed until April 1, the required beginning date, of the subsequent year [IRC section 401(a)(9)(C) and Treasury Regulations section 1.401(a)(9)-5(A-1) (b), (c)]. This creates interpretational difficulty for IRA owners reaching their required beginning dates at age 70½ in 2019 or at age 72 in 2020.
Taxpayers turning 70½ in 2019 would normally have two RMDs due in 2020: 1) a 2019 calendar year RMD due on April 1 2020; and 2) a 2020 calendar year RMD due on December 31, 2020 [see IRC section 401(a)(9) (C)]. These individuals may forgo the 2019 RMD due on April 1, 2020, if it was not already taken before January 1, 2020 (Notice 2020-51). In addition, these individuals may also forgo the calendar year 2020 RMD that would have been due on December 31, 2020.
The ongoing COVID-19 pandemic, pre-existing legislative changes, and proposed/finalized regulatory updates have created a confusing patchwork of new RMD rules for practitioners and clients to navigate.
Similar to the hypothetical taxpayers described above, taxpayers turning 72 in 2020 would normally have two RMDs due in 2021: 1) a 2020 calendar year RMD due on April 1, 2021; and 2) a 2021 calendar year RMD due on December 31, 2021. These individuals may forgo the 2020 calendar-year RMD due on April 1, 2021. However, they must still take the 2021 RMD that is due on December 31, 2021.
How Should Taxpayers Resume RMDs in 2021?
Currently, all taxpayers are required to resume RMDs in 2021 [IRC section 401(a)(9)(I)]. IRA owners and surviving spouses acting as beneficiaries are permitted to recalculate their RMD distribution period every year [Treasury Regulations sections 1.401(a)(9)-5 (A-4)(a),(b)]. Owners and spouses will resume RMDs by going to the applicable lifetime table and locating their age to determine their distribution period. However, advisors should be aware that nonspousal IRA beneficiaries are not permitted to recalculate their RMD distribution period. Nonspousal beneficiaries will need to find their original distribution period and subtract “1” for each year that has passed since their initial distribution calendar year [Treasury Regulations sections 1.401(a) (9)-5 (A-5)(a), (c)].
Update of the Life Expectancy Tables Effective for 2022
Tax professionals should note the finalization of updates to the life expectancy tables used to calculate specific annual RMD amounts in Treasury Regulations section 1.401(a)(9)-9. There are three life expectancy tables: 1) the uniform lifetime table, 2) the single life table, and 3) the joint & last survivor table. The uniform lifetime table covers single IRA owners or married IRA owners with a 10-year or less age gap between spouses. The Single Life Table is used by nonspousal beneficiaries and those surviving spouses electing beneficiary tax treatment. Finally the Joint & Last Survivor Table pertains to married IRA owners with over a 10-year age gap between spouses.
On November 8, 2019, the IRS issued proposed regulatory updates to the above life expectancy tables in response to an executive order by the Trump administration. These regulations were finalized on November 12, 2020 [see Treasury Regulations section 1.401(a)(9)-9, 85 Federal Register 72472]. The new life expectancy tables yield lengthened life expectancies for IRA owners and for beneficiaries using the life expectancy method. For example, a 72-year-old IRA owner under the new proposed regulations has a life expectancy of 27.4 years instead of 25.6 years. The proposed life expectancy tables would apply to distribution calendar years beginning on or after January 1, 2022. [Compare Treasury Regulations section 1.401(a) (9)-9 (2019) with section 1.401(a)(9)-9(c) (2020 effective for distribution calendar years in 2022).]
Be Ready for Anything
The ongoing COVID-19 pandemic, pre-existing legislative changes, emergency legislative changes, and proposed/finalized regulatory updates have created a confusing patchwork of new RMD rules for practitioners and clients to navigate. CPAs should carefully review the new changes under the Secure Act, the CARES Act, Treasury Regulation section 1.401(a)(9)-9, and IRS Notice 2020-51. Tax advisors should also stay vigilant for new legislation or regulations. In addition, IRA owners may want to change their tax and estate plans to reflect these numerous legislative and regulatory changes. The COVID-19 pandemic is not over, and Treasury Regulations 1.401(a)(9)-1–8 have not been reissued to fit the new provisions of the Secure Act. Given the events of 2020, CPAs should be ready for surprises.