Unpleasant Surprise From Proposed Regulation for Non-Spousal Beneficiaries | Sharpe Group
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Posted April 11th, 2022

Unpleasant Surprise From Proposed Regulation for Non-Spousal Beneficiaries

The SECURE Act requires most non-spousal beneficiaries to draw down an inherited Roth or traditional IRA over a 10-year period without requiring a distribution during the first nine years after the death of the original owner.1 Certain “eligible designated beneficiaries,” such as a surviving spouse, disabled or chronically ill beneficiaries or a minor, are exempted from the ten-year payout rule.2 The recently proposed regulations make the new IRA owner subject to annual required minimum distributions (RMDs) during the 10-year period if the deceased account holder died on or after their required beginning date.3

This interpretation contradicts the explanation provide in IRS Publication 590-B EN4:

The 10-year rule requires the IRA beneficiaries who are not taking life expectancy payments to withdraw the entire balance of the IRA by December 31 of the year containing the 10th anniversary of the owner’s death. For example, if the owner died in 2021, the beneficiary would have to fully distribute the IRA by December 31, 2031. The beneficiary is allowed, but not required, to take distributions prior to that date.

This proposed regulation means inheriting beneficiaries of an IRA account must calculate their RMD. Inheritors must take RMD distributions to avoid the 50% penalty on the amount of the shortfall.

Let’s illustrate the impact of required annual distributions during the 10 years with some examples.

Example 1

In 2022, Uncle Harry dies at 73 and leaves his IRA to Niece Nora, age 58. Her RMDs must begin in 2022 and conclude in 2032, 10 years after the death of Uncle Harry. Nora now has a greater-than-anticipated tax burden. Since there is no requirement that the payments be annuitized over 10 years, Nora might consider taking more than the RMD, especially if she has any plans to make charitable contributions.

Nora will need to receive two payments in 2022 and should file Form 5329 to waive the 50% penalty. The proposed regulation eliminates flexibility, which would have been accorded under IRS Publication 590-B. Tax planning for Niece Nora now requires management of her marginal tax rate. She may wish to coordinate her charitable giving with the amount of RMDs she is taking.

Example 2

Same facts as Example 1, except Uncle Harry was 93 at death, and Nora is over the age of 70 ½. Tax planning for Niece Nora now should include whether a qualified charitable distribution (QCD) should be made since any QCDs will count toward the RMD. Of course, she could make a deductible contribution in lieu of or in addition to the QCD.

While inheritors of traditional IRAs lost the ability to avoid RMDs for nine years, inheritors of Roth IRAs did not. The Roth IRAs can continue to grow tax-free and distribution-free until Dec. 31st of the year containing the 10th anniversary of the first owner’s death.

Example 3

Same facts as Example 1, except Uncle Harry also leaves his Roth IRA to Niece Nora in addition to his traditional IRA. Niece Nora will still need to calculate annual RMDs from the regular IRA. However, there are no such annual RMDs for the Roth IRA, which will still need to be paid out in full per the 10-year rule.

Those tax practitioners who believe the proposed regulations incorrectly interpret the enacted legislative may comment by May 25. I anticipate strong advisor objection to this interpretation.

By Professor Christopher P. Woehrle, JD, LLM.

Endnotes

  1. Internal Revenue Code, sec. 401(a)(9)(H)(i).
  2. Internal Revenue Code, sec. 401(a)(9)(H)(ii).
  3. See proposed regulations.
  4. IRS Publication 590-B (Distributions from Individual Retirement Arrangements), page 11.

 

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