Proposed regulations[1] dealing with changes made in the SECURE Act to required minimum distributions were released by the IRS.  The proposed regulations do have some surprises for taxpayers, some not very welcome while others are fairly favorable.

Jeff Levine, CPA/CVA, CFP has a long Twitter thread in which he discusses these proposed regulations.[2]

We will be using his very useful summary as a guide to the key issues for this new set of proposed regulations.

Effective Date

The regulations provide for a proposed effective date for tax years beginning and transactions taking place on or after January 1, 2022.[3]

Non-Designated Beneficiaries for Inherited IRAs

The SECURE Act made significant changes to rules related to inherited IRAs.  However, the biggest changes were made to distributions to designated beneficiaries.

Non-designated beneficiaries are, generally, entities other than individuals such as charities, decedent’s estates, and trusts (other then conduit trusts where we are allowed to “look through” the trust to determine ultimate living beneficiaries).

For non-designated beneficiaries the rules remain much the same as they were prior to the SECURE Act.  If the covered employee/IRA holder dies before he/she reaches their required beginning date, then the balance of the plan must be distributed within the same 5-year period as before.[4]  If the covered employee/IRA holder dies after reaching his/her required beginning date, then the remaining balance must be distributed per IRC §401(a)(9)(B)(i) using the now deceased person’s remaining life expectancy at the date of death (as absurd as that sounds).

Designated Beneficiaries Other Than Eligible Designated Beneficiaries

Prior to the SECURE Act, federal law divided beneficiaries into two classes, one of which being the non-designated beneficiaries described in the prior section and designated beneficiaries.  Designated beneficiaries included all individuals as well as trusts with specific provisions outlined in the regulations that allowed looking at living trust beneficiaries.

Under the SECURE Act the category of designated beneficiaries is further subdivided to create a special class known as eligible designated beneficiaries we will discuss later.  In this section, we consider the general class of designated beneficiaries who aren’t offered the options granted to those classes of beneficiaries that are part of the eligible designated beneficiary category, which we’ll refer to as non-eligible designated beneficiaries.

The non-eligible designated beneficiaries will make up the largest group for non-spouse beneficiaries, becoming in many ways the default class of beneficiaries.

Death Before Reaching Required Beginning Date

In the case of an inherited plan interest or IRA where the original beneficiary had not reached his/her required beginning date before passing away, the non-eligible designated beneficiary must take all funds from the account by the end of the 10th year following the year the original account interest holder passed away.[5] 

There is no requirement that any amount be taken in any particular year, so long as all funds are withdrawn from the account by the end of the 10th year.  Essentially, these are the same rules as under the 5-year distribution rules except a non-eligible designated beneficiary gets 10 years rather than 5 years to take the funds out.

Prior to the SECURE Act designated beneficiaries could be offered an option to (or even be required to) take distributions based on the primary designated beneficiary’s life expectancy beginning in the year following the year of death.  The SECURE Act was enacted specifically to remove this option which was used to create stretch IRA plans.

Death After Reaching Required Beginning Date

After the passage of the SECURE Act, many commentators believed that the rules would be identical for non-eligible designated beneficiaries even if the original beneficiary had reached his/her required beginning date except for the need to assure the required minimum distribution for the decedent was taken before the end of year of the death if it hadn’t been taken before the date of death.

However, remember that bit at IRC §401(a)(9)(B)(i) we mentioned earlier.  Well IRC §401(a)(9)(B) reads as follows:

(B) Required distribution where employee dies before entire interest is distributed

(i) Where distributions have begun under subparagraph (A)(ii)

A trust shall not constitute a qualified trust under this section unless the plan provides that if--

(I) the distribution of the employee's interest has begun in accordance with subparagraph (A)(ii), and

(II) the employee dies before his entire interest has been distributed to him,

the remaining portion of such interest will be distributed at least as rapidly as under the method of distributions being used under subparagraph (A)(ii) as of the date of his death.

The IRS proposed regulations read this provision of the law, which was not changed by the SECURE Act, as requiring distributions to be made during each of the first nine years following the year of death using the calculated required minimum distribution used under pre-SECURE Act law and regulations,[6] followed by a required distribution of the remaining balance in year 10.

The IRS explains in the preamble to the proposed regulations:

Section 401(a)(9)(B)(i) provides rules that apply if an employee dies after benefits have commenced. While the 5-year rule under section 401(a)(9)(B)(ii) (expanded to a 10-year rule in certain cases by section 401(a)(9)(H)(i)(I)) generally applies if an employee dies before the employee’s required beginning date, section 401(a)(9)(H)(i)(II) provides that section 401(a)(9)(B)(ii) applies whether or not distributions have commenced. Accordingly, if an employee dies after the required beginning date, distributions to the employee’s beneficiary for calendar years after the calendar year in which the employee died must satisfy section 401(a)(9)(B)(i) as well as section 401(a)(9)(B)(ii). In order to satisfy both of these requirements, these proposed regulations provide for the same calculation of the annual required minimum distribution that was adopted in the existing regulations but with an additional requirement that a full distribution of the employee’s entire interest in the plan be made upon the occurrence of certain designated events (discussed in section I.E.3.c. of this Explanation of Provisions).[7]

Designated Beneficiaries Who Are Eligible Designated Beneficiaries

Certain designated beneficiaries retained the right to, at least for a period of time, continue to take distributions using their life expectancies.  These beneficiaries, referred to as eligible designated beneficiaries under the law, are:

• Minor children of the decedent

• Individuals who are disabled

• Persons who are chronically ill

• Persons not more than 10 years younger than the deceased individual and

• Surviving spouses.

Minor Children

Under the SECURE Act, a minor child of the decedent is an eligible designated beneficiary if the child had not reached the age of majority by the time of the employee’s death.  That child has a limited time during which he/she is an eligible designated beneficiary, with the status ending as of the date the child attains the age of majority.  At that time the balance must be distributed within 10 years after the child attains the age of majority.[8]

But a key question was what was meant by this rule for age of majority? The proposed regulations provide that attaining the age of majority takes place on the child’s 21st birthday.[9]

Disabled Individuals

The proposed regulations provide separate definitions of a disabled individual depending on whether the individual has or has not attained age 18 as of the death of the original interest holder in the account.  As well, the proposed regulations provide a safe harbor based on a social security determination of disability.

For an individual who is 18 or older, the proposed regulations provide the following definition of disabled:

An individual who, as of the date of the employee’s death, is age 18 or older is disabled if, as of that date, the individual is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or to be of long-continued and indefinite duration.[10]

For younger beneficiaries, the proposed regulations provide the following definition:

An individual who, as of the date of the employee’s death, is not age 18 or older is disabled if, as of that date, that individual has a medically determinable physical or mental impairment that results in marked and severe functional limitations and that can be expected to result in death or to be of long-continued and indefinite duration.[11]

Finally, the proposed regulations provide the following safe harbor definition of disabled based on social security rules:

If the Commissioner of Social Security has determined that, as of the date of the employee’s death, an individual is disabled within the meaning of 42 U.S.C. 1382c(a)(3), then that individual will be deemed to be disabled within the meaning of this paragraph (e)(4).[12]

The proposed regulations also provide rules for mandatory documentation that must be provided to the plan administrator in the year following the year of death for a beneficiary to meet these qualifications.[13]

Chronically Ill Individual

The proposed regulations give the following definition for a chronically ill individual:

An individual is chronically ill if the individual is chronically ill within the definition of section 7702B(c)(2) and satisfies the documentation requirements of paragraph (e)(7) of this paragraph. However, for purposes of the preceding sentence, an individual will be treated as chronically ill under section 7702B(c)(2)(A)(i) only if there is a certification from a licensed health care practitioner (as that term is defined in section 7702B(c)(4)) that, as of the date of the certification, the individual is unable to perform (without substantial assistance from another individual) at least 2 activities of daily living for an indefinite period which is reasonably expected to be lengthy in nature (and not merely for 90 days).[14]

Note the mandatory requirement there be a certification from a licensed health care practitioner.

Similar documentation rules to those that apply for disabled individuals apply to the chronically ill individuals, requiring delivery of this information to the plan administrator in the year following the year of death.[15]

Beneficiary Not More Than 10 Years Younger Than Decedent

The proposed regulations use the actual date of birth, not just the year of birth, to determine if the beneficiary is not more than 10 years younger than the decedent:

Whether a designated beneficiary is not more than 10 years younger than the employee is determined based on the dates of birth of the employee and the beneficiary. Thus, for example, if an employee’s date of birth is October 1, 1953, then the employee’s beneficiary is not more than 10 years younger than the employee if the beneficiary was born on or before October 1, 1963.[16]

Surviving Spouse and Delay Until Spouse’s Required Beginning Date

The law had previously allowed a surviving spouse to treat a retirement account as his/her own and start benefits under his/her RMD at their required beginning date even if the spouse had already begun taking required distributions.  However, some had worried that although the law moved this age to age 72 that spouses that had previously inherited their interest in years prior to the effective date of the SECURE Act might still be required to begin distributions at age 70 ½.

The proposed regulations provide for a single age 72 required beginning date for surviving spouses regardless of when they inherited their interest—that is, there is no special age 70 ½ rule for those who inherited funds earlier.[17]

Can an Eligible Beneficiary Use the 10-Year Rule Rather than Their Life Expectancy

Another question that remained to be answered following the enactment of the SECURE Act changes was whether an eligible designated beneficiary could opt to use the 10-year payout method rather than their own life expectancy.  The regulations allow this but also allow a plan to bar the use of the life expectancy method.

The regulations, in describing optional plan provisions, provides:

A defined contribution plan will not fail to satisfy section 401(a)(9) merely because it includes a provision specifying that the 10-year rule described in paragraph (c)(3) of this section (rather than the life expectancy rule described in paragraph (c)(4) of this section) will apply with respect to some or all of the employees who have an eligible designated beneficiary. Further, a plan need not have the same method of distribution for the benefits of all employees in order to satisfy section 401(a)(9).[18]

Other Areas Covered

The proposed regulations have additional changes made to conduit trusts and the treatment of successor beneficiaries I don’t have time to cover here during tax season.  However, Jeff Levine’s Twitter analysis will give you a good overview of these provisions and I suggest reading it if you have interests in these areas.[19]

For now, it’s important to remember these are still proposed regulations, and that there may be significant changes made when final regulations are issued.  But this gives us some ideas about how the IRS is thinking in this area.

[1] REG-105954-20, Federal Register Vol. 87, No. 37, February 24, 2022, p. 10504, https://www.govinfo.gov/content/pkg/FR-2022-02-24/pdf/2022-02522.pdf (retrieved February 27, 2022)

[2] Jeff Levine CPA/CVA, CFP, Twitter Thread, February 23, 2022, https://twitter.com/CPAPlanner/status/1496654100792029184?s=20&t=aDl3ZzWBzRIVA5VlgVPt4Q (retrieved February 27, 2022)

[3] REG-105954-20, Federal Register Vol. 87, No. 37, February 24, 2022, p. 10521

[4] Proposed Reg. §1.401(a)(9)-3(c)(5)

[5] Proposed Reg. §1.401(a)(9)-3(c)(3)

[6] Proposed Reg. §1.401(a)(9)-5(d)

[7] Preamble to the Proposed Regulations Section I.E.3.a, REG-105954-20, Federal Register Vol. 87, No. 37, February 24, 2022

[8] IRC §401(a)(9)(E)(iii)

[9] Proposed Reg. §1.401(a)(9)-4(e)(3)

[10] Proposed Reg. §1.401(a)(9)-4(e)(4)(ii)

[11] Proposed Reg. §1.401(a)(9)-4(e)(4)(iii)

[12] Proposed Reg. §1.401(a)(9)-4(e)(4)(iv)

[13] Proposed Reg. §1.401(a)(9)-4(e)(7)

[14] Proposed Reg. §1.401(a)(9)-4(e)(5)

[15] Proposed Reg. §1.401(a)(i)-4(e)(7)

[16] Proposed Reg. §1.401(a)(9)-4(e)(6)

[17] Proposed Reg. §1.402(c)-2(j)(3)(iii)

[18] Proposed Reg. §1.401(a)(9)-3(c)(5)(ii)

[19] Jeff Levine CPA/CVA, CFP, Twitter Thread, February 23, 2022, https://twitter.com/CPAPlanner/status/1496654100792029184?s=20&t=aDl3ZzWBzRIVA5VlgVPt4Q (retrieved February 27, 2022)