By Rick Allen, CPA-East Texas, Julie Dale, CPA-Austin and Tom Ochsenschlager, J.D., CPA
The distribution rules pertaining to inherited IRAs received from decedents dying after 2019 have changed dramatically as a result of the Setting Every Community Up for Retirement Enhancement (SECURE) Act and the SECURE 2.0 Act. Understanding these rules is extremely important as failure to apply the new rules properly can result in missed opportunities and possibly an excise tax along with penalties. This article focuses on non-spouse, non-eligible designated beneficiaries since this is where the most drastic change can be observed between the old and new law. A surviving spouse beneficiary still has the option to stretch the required distributions over life expectancy.
IRA Inherited from Decedent Passing Away Before Jan. 1, 2020
For inherited IRAs received from decedents passing away before Jan. 1, 2020, the distribution rules were generally more favorable than the new SECURE Act rules. A non-spouse designated beneficiary who inherited an IRA prior to the decedent’s required beginning date (RBD) could:
- elect to take IRA distributions under the “5-year rule” whereby the entire balance of the inherited IRA had to be distributed by Dec. 31 of the 5th year following the decedent’s death with no annual required minimum distributions (RMDs), or
- use the stretch IRA rules, which provided for the use of the Single Life Table based on the beneficiary’s life expectancy (reduced by 1 for each year thereafter).
A non-spouse designated beneficiary who inherited an IRA after the decedent’s RBD could use the stretch IRA rules that provided for the use of the Single Life Table based on the IRA owner’s age at date of death (reduced by 1 for each year thereafter). The stretch distributions must begin by Dec. 31 of the year following the decedent’s death. With the use of the 5-year rule, no distributions were required until Dec. 31 of the fifth year following the decedent’s death.
IRA Inherited from Decedent Passing Away After Dec. 31, 2019
For an IRA inherited from a decedent passing away after Dec. 31, 2019, a new distribution regimen is in place for many IRA beneficiaries. The most striking difference is for non-spouse, non-eligible designated beneficiaries.
We will start with a few definitions added by the SECURE Act since an understanding of these terms is required to follow the remainder of the article. These definitions can be found in IRC Section 401(a)(9)(E).
- A designated beneficiary means any individual designated as a beneficiary by the employee.
- Eligible designated beneficiaries have special exceptions or delays to the 10-year rule discussed below. Eligible designated beneficiary means a beneficiary designated by the employee who is:
- the surviving spouse of the employee;
- a child of the employee who has not reached majority (10-year rule takes effect when child reaches majority);
- disabled within the meaning of Section 72(m)(7);
- a chronically ill individual (within the meaning of Section 7702B(c)(2), except that the requirements of subparagraph (A)(i) thereof shall only be treated as met if there is a certification that, as of such date, the period of inability described in such subparagraph with respect to the individual is an indefinite one which is reasonably expected to be lengthy in nature); or
- an individual not described in any of the preceding subclauses who is not more than 10 years younger than the employee.
- A non-eligible designated beneficiary would be a designated beneficiary who does not meet the requirements to be considered an eligible designated beneficiary.
The old “5-year rule” has been replaced with a new “10-year rule” for a non-eligible, designated beneficiary with no option for stretching the distributions over the beneficiary’s or decedent’s life expectancy. The statutory language indicates that the 5-year rule is simply replaced by the 10-year rule so the account balance must be fully distributed by Dec. 31 of the 10th year following the decedent’s date of death. The IRS correctly interpreted that the old 5-year rule meant no distributions were required until the end of the 5th year following the decedent’s date of death. For the new 10-year rule, the IRS chose to break with its own interpretation of the 5-year rule in the new proposed regulations and requires annual RMDs during the 10 years based on life expectancy for IRAs inherited from a decedent who had already met the RBD. The IRS chose this interpretation even though the plain wording of the law passed by Congress states otherwise. IRC Section 401(a)(9)(H)(i)(II) states clearly that the new 10-year rule shall apply whether or not distributions of the decedent’s interests have begun in accordance with subparagraph A. So, the decedent’s RBD is irrelevant according to the language adopted.
Since the IRS did not issue the proposed regulations until February 2022, a taxpayer who inherited an IRA account in 2020 had already missed the RMD for 2021 without the ability to avoid the penalty. The tax professional community pushed back on these proposed rules (including TXCPA’s Federal Tax Policy Committee). The IRS clarified in Notice 2022-53 and Notice 2023-54 that penalties for not making RMDs from inherited IRAs for decedents dying after Dec. 31, 2019, would not be assessed in 2021, 2022 and 2023. The final regulations when issued will only apply to 2024 and later years.
Many professionals believe that RMDs are not required to be made under the 10-year rule according to a reasonable, straightforward reading of the statutory language. The IRS has not engaged on this issue even though comments were submitted by tax practitioners and the public. The IRS appears to be sticking with its erroneous interpretation requiring annual RMDs based on the recent language used in Notice 2023-54. TXCPA’s Federal Tax Policy Committee is currently preparing a letter addressed to Congress to bring attention to the IRS requirement for annual RMDs that was issued in direct opposition of the statute adopted by Congress. It would still be wise to consider advising the annual RMD be made pursuant to the proposed regulations in 2024 for an IRA inherited by a non-eligible, designated beneficiary under the new 10-year rule unless further guidance is received.