Final RMD rules retain 10-year rule for inherited retirement accounts

The IRS recently issued final regulations (TD 10001) implementing legislative changes to the required minimum distribution (RMD) rules, and the Service largely declined to soften unfavorable proposed rules for inherited retirement accounts.

The RMD rules were amended by both the SECURE Act of 2019 and the SECURE 2.0 Act of 2022. The IRS issued proposed regulations in February 2022, and the final regulations make relatively minimal changes in response to comments received.

The RMD rules generally require distributions from certain tax-favored retirement plans (e.g., Section 401(k) plans, Section 403(b) plans, individual retirement accounts (IRAs) and eligible Section 457(b) plans) after an employee/account owner reaches a specific age and after death. The rules set forth a required beginning date (RBD) for distributions and identify the period over which the employee’s or account owner’s entire interest must be distributed.

The SECURE Act of 2019 made two significant changes to the pre-existing RMD rules:

• Increasing the RBD age threshold from age 70-1/2 to age 72, effective for employees attaining age 70-1/2 after 2019
• Replacing the five-year rule for employees who die before their RBD with a new 10-year rule that applies for all post-death distributions except for certain eligible designated beneficiaries (e.g., surviving spouses; minor children), effective for deaths occurring after 2019

The SECURE 2.0 Act of 2022 made additional changes to the RMD rules, including, but not limited to:

• Increasing the RBD age threshold from age 72 to age 73, effective for participants attaining age 72 after 2022
• Increasing the RBD age threshold from age 73 to age 75, effective for participants attaining age 73 after 2032

The final regulations retain without any changes one of the more controversial positions taken by the IRS in the 2022 proposed regulations regarding the new 10-year rule for post-death distributions.

Before the new 10-year rule was added, post-death distributions under a retirement account could generally be spread over the remaining life expectancy of the designated beneficiary. As a result, designating a younger beneficiary under a retirement account generally could reduce the amount of post-death RMDs that would need to be made each year following the death of the employee.

This prior rule was the basis for referring to certain IRAs as “stretch IRAs” — which were regular IRAs in which the account owner designated a younger beneficiary such as a child or grandchild, and any post-death distributions could be spread over the remaining life expectancy of the child or grandchild following the death of the account owner. 

The new 10-year rule was adopted to eliminate the stretch IRA/retirement account and limit the maximum post-death distribution period to 10 years for designated beneficiaries other than certain eligible designated beneficiaries (e.g., surviving spouses; minor children).

The 2022 proposed regulations included a controversial position with respect to the new 10-year rule when a retirement account owner dies after the owner’s RBD and annual RMDs have commenced, and the designated beneficiary is not an eligible-designated beneficiary (e.g., a non-spouse beneficiary). In this scenario, the proposed regulations provided that a non-spouse beneficiary must continue to take annual RMDs after the death of the owner and must receive a complete distribution of the entire account balance no later than the end of the 10^th calendar year following the calendar year of the owner’s death. 

This position surprised many practitioners, retirement plan administrators and holders of inherited IRAs/retirement accounts who thought the new 10-year rule would not require continued annual RMDs during the 10-year period, but rather would only require the entire remaining account to be distributed at some point before the end of the 10-year period. The inherited account holders thought they would have flexibility to determine when and how much to distribute from the accounts during the post-death 10-year period.

The new 10-year rule was enacted to be effective for deaths occurring after 2019. In response to this controversy and significant requests for transition relief, the IRS issued three notices to provide penalty relief for any RMDs that should have been made under the new 10-year rule in calendar years 2021 through 2024 (see IRS Notices 2022-53, 2023-54 and 2024-35). Under this relief, an inherited account holder who failed to take an annual RMD in those years in accordance with the 2022 proposed regulations would not be assessed an excise tax under Section 4974 for failing to do so.

As noted, the final regulations retain the new 10-year rule as originally proposed in 2022 with no changes. In rejecting the requested changes, the IRS explained in the preamble to the final regulations that its original position is consistent with a plain reading of the applicable statutory language and is consistent with the overarching policy of the RMD rules and the amendments made by the SECURE Act of 2019.

The final regulations also extend the applicability date in the proposed regulations from distribution calendar years beginning on or after Jan. 1, 2022, to distribution calendar years beginning on or after Jan. 1, 2025.

As noted, the new 10-year rule was enacted effective for deaths occurring after 2019. Although the IRS provided penalty transition relief for calendar years 2021 to 2024 and the final regulations generally apply to distribution calendar years beginning in 2025, the final regulations provide that the applicable 10-year period for deaths occurring after 2019 has not been extended. For example, the applicable 10-year period for an account owner who died in 2020 would expire at the end of calendar year 2030, and not in 2034. Thus, a non-spouse beneficiary of an inherited IRA whose owner died in 2020 generally would have to start taking annual RMDs with respect to the IRA in accordance with the final regulations beginning in 2025 and generally would have to distribute an amount equal to the entire account balance no later than the end of the 2030 calendar year. 

The IRS also issued proposed regulations (REG-103529-23) for various provisions that were reserved in the 2024 final regulations, primarily involving certain changes made by the SECURE 2.0 Act of 2022, including:

• Applicable age determinations for employees born in 1959
• Purchases of annuity contracts with a portion of an employee's individual account
• Distributions from designated Roth accounts
• Section 4974 excise tax waivers
• Spousal elections under Section 327 of the SECURE 2.0 Act
• Divorce after the purchase of a qualifying longevity annuity contract
• Outright distributions to a trust beneficiary

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