Which beneficiaries are subject to RMDs by year-end?

Year-end means required minimum distribution season, since that’s typically when clients take RMDs.

But year-end is also when lots of costly RMD mistakes happen — costly because of the 50% penalty on any part of the RMD that’s not taken. Fortunately, the IRS has temporarily waived the penalty for beneficiaries who originally would have been subject to new RMD rules for this year (and last year).

There are also new life expectancy tables for 2022 RMDs which will lower the RMD amount slightly for most clients.

USE NEW IRS TABLES

IRS updated the life expectancy tables for 2022 for both IRA owners and beneficiaries, which can be found in IRS Publication 590-B. These tables should be used by IRA owners, plan participants and beneficiaries subject to RMDs this year.

For IRA owners, it’s relatively easy. The SECURE Act raised the RMD age to 72. The required beginning date is April 1 of the year following the year you turn age 72. Those who turned 72 in 2022 have until April 1, 2023, to take their first RMD.

But if they wait until the next year to take that RMD, they must take two RMDs in 2023, bunching that income into one tax year. It’s usually better for clients to take their first RMD by the end of the year they turn 72 so they can separate their first two RMDs into two tax years, generally lowering the tax bill in each year.

That’s the easy part. Now to the beneficiaries.

WHO’S SUBJECT TO RMDS IN 2022?

That’s a loaded question now due to the complexities created by the SECURE Act, the proposed regulations the IRS issued early this year, and the IRS relief announced Oct. 7 in Notice 2022-53.

Here’s a snapshot of beneficiaries subject to RMDs:
• Designated beneficiaries who inherited before 2020.
• Designated beneficiaries who inherit in 2020 or later when the account owner dies on or after his required beginning date — for years one through nine of the 10-year period. However, the IRS waived the 50% penalty for missed 2021 or 2022 RMDs for this category only.
• Eligible designated beneficiaries, or EDBs.
• Non-designated beneficiaries when the account owner dies on or after his required beginning date — for “ghost rule” RMDs.

The SECURE Act eliminated the stretch IRA and replaced it with a 10-year rule for most non-spouse beneficiaries who inherited in 2020 or later when the law took effect. Beneficiaries (non-spouses, such as children or grandchildren) who inherited before 2020 and qualified for the extended payout (the stretch IRA) can continue those stretch IRA RMDs.

In addition, eligible designated beneficiaries still qualify for the stretch IRA, but they must first qualify as a designated beneficiary by being named on the IRA or employer plan beneficiary form.

Here are the five classes of eligible designated beneficiaries:
1. Surviving spouses.
2. Minor children of the account owner, until age 21 — but not grandchildren.
3. Disabled individuals — under strict IRS rules.
4. Chronically ill individuals.
5. Individuals older than, or not more than 10 years younger than, the IRA owner.

OTHER DESIGNATED BENEFICIARIES

Under the IRS proposed rules, other designated beneficiaries who inherited in 2020 from someone who died after their required beginning date (after age 72, for example) would have been required to start taking an annual RMD last year. For deaths in 2021, annual RMDs would have needed to start in 2022. These groups of beneficiaries are subject to the 10-year rule requiring the entire balance to be withdrawn by the end of the 10^th year after death. But in addition, since they inherited from someone who had already begun RMDs, those beneficiaries also must normally take RMDs for years one through nine of the 10-year term.

IRS RMD RULE UPDATE

However, in Notice 2022-53, the IRS waived the 50% penalty for beneficiaries in these categories who didn’t take a 2021 RMD and who don’t take a 2022 RMD. Importantly, this gift from the IRS doesn’tapply to any other category of beneficiaries subject to RMDs (see the list above).

For example, if IRA owner Dad died in 2021 at age 75 (after his RBD), and daughter Mary (age 50 in 2022) inherited, Mary originally would have needed to begin RMDs in 2022 based on her age this year. Now Mary doesn’t have to worry about a penalty if she doesn’t take the 2022 RMD. Pending further IRS guidance, Mary will have to start taking annual RMDs in 2023 — the second year of her 10-year period.

Note: Roth IRA beneficiaries are not subject to RMDs in years one through nine, since all Roth IRA owners are deemed to have died before their required beginning date, regardless of their age at death.

[More: The new IRS 10-year RMD rule isn’t what we thought it was]

NON-DESIGNATED BENEFICIARIES

This is the category for beneficiaries who are either not individuals or weren’t named on the beneficiary form (and likely inherited through the estate). This group gets the least favorable RMD treatment. Examples of non-designated beneficiaries include an estate, a charity or a nonqualifying trust (non-look-through trust).

The SECURE Act didn’t change these rules. For non-designated beneficiaries, RMDs are based on whether the IRA owner or plan participant dies before or after the owner’s required beginning date, which is generally April 1 after the year of the 72^nd birthday.

If the owner dies before the required beginning date, the account must be withdrawn by the end of the fifth year after death — the 5-year rule. There are no annual RMDs during the 5-year window. If the non-designated beneficiary inherited under the 5-year rule in 2016, then the remaining balance must be withdrawn by the end of this year. This comes out to 6 years because 2020 doesn’t count, since RMDs were waived for that year.

If the owner dies on or after the required beginning date, RMDs must be taken over the deceased’s remaining single life expectancy — aka the “ghost life rule.” (This can produce a post-death payout exceeding 10 years).

EXAMPLE

Mom died in 2021 at age 80 but neglected to name a beneficiary on her IRA beneficiary form. The estate became the default beneficiary, and her son Tom inherited through the estate. Tom is a non-designated beneficiary, since he inherited through the estate and not through the beneficiary form. Tom must take an RMD this year based on Mom’s remaining single life expectancy from the Single Life Expectancy Table. (He doesn’t get relief from the IRS if he misses the RMD.) Mom died at 80, when her life expectancy factor from the table would have been 11.2 years. For his 2022 RMD, Tom will use a factor of 10.2 years, and he will reduce that by one year for each succeeding year.

YEAR-OF-DEATH RMDs

In addition to the above list of beneficiaries subject to RMDs, there are year-of-death RMDs that may need to be taken.

If the IRA owner died this year and didn’t yet take his or her 2022 RMD, the IRS used to require that it be taken by the beneficiary before year-end. The RMD is the amount the IRA owner would have taken had he or she lived.

However, if the beneficiary doesn’t take that RMD in time, IRS rules now allow an automatic waiver of the 50% penalty. This waiver is available if the year-of-death RMD is taken by the beneficiary’s tax filing deadline, including extensions. It’s good to know this one, especially at year-end.

[More: Inherited IRA RMD rules 2023: RMD quirks that IRA beneficiaries face in ’23]

CONTACT BENEFICIARIES

Make sure you contact all beneficiaries who are subject to RMDs before year-end. Given the combination of the SECURE Act, the pre-SECURE Act RMD rules and the 2022 IRS proposed regulations, many beneficiaries may not be aware that they are subject to RMDs for 2022. Help them avoid the 50% penalty for not taking them. For other beneficiaries, you can share the good news that the IRS has given them a reprieve on the penalty they would have owed for missed 2021 and 2022 RMDs.

[More: Can you take an RMD in stock?]

For more information on Ed Slott and Ed Slott’s 2-Day IRA Workshop, please visit www.IRAhelp.com.