In response to recent legislative changes, IRS Notice 2023-54 expands the relief already provided to taxpayers subject to the so-called “10-year rule” for inherited IRAs and other defined contribution plans.

The SECURE Act

Before enactment of the original SECURE Act, beneficiaries of inherited IRAs could “stretch” the required minimum distributions (RMDs) on the funds over their entire lives. For younger heirs, the stretch period may last for decades. This enables them to accept lesser payments and postpone taxes as the accounts grow. The choice was then open to these heirs to pass on their IRAs to successive generations. But that could potentially delay tax obligations even longer.

The SECURE Act repealed the provisions allowing many heirs to receive extended RMDs to hasten tax collection. This refers to designated beneficiaries rather than eligible designated beneficiaries (EDBs). The law generally requires that the distribution of the entire account value be within ten years of death for IRA owners or participants in defined contribution plans who passed away in 2020 or later. The regulation is still in effect whether the dead passes away before, on, or after the required beginning date (RBD) for RMDs from the plan. EDBs may choose to apply the 10-year rule treatment if the deceased died before the RBD. Otherwise, they may continue to spread payments across their life expectancies.

The 10-year rule

Beneficiaries can satisfy the 10-year rule by taking the entire amount before the end of the calendar year. That includes the 10th anniversary of the death, according to proposed IRS regulations released in February 2022 for designated beneficiaries who inherit an IRA or defined contribution plan before the deceased’s RBD. However, suppose the decedent passes away on or after the RBD. In that case, the designated beneficiaries must take taxable yearly RMDs in years one through nine and get the leftover balance in year ten. Note that those RMDs are based on their life expectancies. They cannot accept a lump-sum payout of the total account after waiting until the conclusion of the ten years. The annual RMD rule would limit the tax planning options available to designated beneficiaries. In this example, and especially if they work, they may be in a higher tax bracket during those years.

The 10-year rule and the proposed regulations have caused some confusion. Many designated beneficiaries who inherit IRAs or defined contribution plans are now unsure when to start taking RMDs. For instance, the IRS heard from the heirs of relatives who passed away in 2020. These heirs weren’t sure about taking RMDs in 2022 because they did not in 2021.

The IRS previously deferred enforcement against taxpayers subject to the 10-year rule who missed the 2021 and 2022 RMDs if the plan participant passed away in 2020 on or after the RBD in light of the unanswered questions. If the person passed away in 2021 on or after the RBD, the missed 2022 RMDs were also excused. The most recent recommendation expands on that relief. It absolves 2023 missing RMDs in cases where the date of passing is on or after the RBD in 2020, 2021, or 2022.

Final regulations are pending

The relief means that covered individuals do not need to worry about being hit with excise tax equal to 25% of the amounts that should’ve been distributed but weren’t. Nor do they need to worry about the excise tax equal to 10% of those amounts if the failure to take the RMD has a timely correction. Additionally, there is no penalty for plans if they don’t make an RMD in 2023, as the proposed regulations require.

The IRS stated in the advisory that the RMD final regulations would not take effect until at least 2024. The EPA had previously noted that the final regulations would only take effect in 2023. When the IRS publishes the final regulations, we’ll let you know how they might apply to you. Do not hesitate to contact RRBB Advisors with any questions. In the meantime, check out part one of this two-part blog post for some background information!

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