Tax Planning for Retirees

Required Minimum Distributions for Plans and IRAs

Increase in the Prescribed Age for Required Minimum Distributions. – Participants in tax favored retirement plans must generally begin making minimum distributions at a prescribed age, or in some cases later when they retire. The SECURE Act of 2019 increased the prescribed age from 70 ½ to 72 for years after 2019. The SECURE 2.0 Act of 2022 increases the prescribed age to 73 starting on January 1, 2023, and further increases the age to 75 for years after 2032. Although the pertinent language of the SECURE 2.0 Act is ambiguous, Congressional leadership has confirmed by letter to the Secretary of the Treasury and the Commissioner of Internal Revenue that the above interpretation of the statutory language is the intended meaning. (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 107; Congressional leadership letter dated May 23, 2023.) See Chapter 8 of the treatise.

Extended Rollover Period for Plan Participants Attaining Age 72 in 2023. – If a participant in a qualified plan or IRA reached age 72 in 2023, the participant had until September 30, 2023 to roll over a distribution received from the plan or IRA during the period January 1, 2023 to July 31, 2023. (Notice 2023-54, 2023-31 I.R.B. ___) See Chapter 8 of the treatise.

IRS Not Penalizing Certain Failures to Make Minimum Distributions. – Practitioners had expected that the new ten-year distribution rule applicable to designated beneficiaries under the Secure Act of 2019 would entirely supersede the old rule that required life-expectancy distributions to be made to a designated beneficiary when a participant died on or after his or her required beginning date. Practitioners had also expected that the new successor ten-year distribution rule would entirely supersede the old rule requiring continuation of life-expectancy distributions after the death of a beneficiary.

Instead, in both cases, the final regulations continue to apply the old rules requiring life-expectancy distributions. The new ten-year distribution rules are treated simply as limitations superimposed over the old life-expectancy distribution requirements. Fortunately, the IRS has recognized the unfairness of holding taxpayers to its unexpected interpretations of the new ten-year rules for periods before issuance of the final regulations. Consequently, for the years 2021, 2022, and 2023, the IRS is not penalizing failures to make life-expectancy distributions to beneficiaries who were subject to the ten-year rules. (Minimum distributions were of course not required for 2020.)

Note that the IRS did not state that it was reclassifying actual distributions in those years as being anything other than required minimum distributions (RMDs). It merely declined to impose a penalty if the RMDs were not made. Consequently, since RMDs may not be rolled over to another plan or IRA, attempted rollovers of any actual RMDs in those years might become subject to the excise tax on excess contributions. (Notice 2022-53, 2022-45 I.R.B. 437; Notice 2023-54, 2023-31 I.R.B. ___) See Chapter 8 of the treatise.

The Percentage Limitation on QLAC Premiums Repealed and the Dollar Limitation Reset. – A retiree may defer the starting date of qualifying longevity annuity contracts (QLACs) until age 85 without violating minimum distribution rules. However, in past years, the aggregate QLAC premiums paid during a retiree’s lifetime by all his or her plans and IRAs could not exceed a dollar amount ($145,000 for 2022). Nor could cumulative premiums paid by any one plan exceed 25 percent of the plan’s account balance. Congress has now repealed the percentage limitation and reset the dollar limitation to $200,000 (for 2023 and adjusted for inflation thereafter). (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 202.) See Chapter 8 of the treatise.

Alternative Election for Computing RMDs on Partial Annuitizations. – When only part of the funds in a defined contribution plan is used to purchase an annuity, the minimum distribution rules for annuities have generally applied to the annuity and the rules applicable to non-annuities have applied to the remainder of the funds. However, a retiree may now elect to compute the minimum distribution for a year by subtracting the actual annuity distributions during the year from the “total required distribution.” The total required distribution is determined by including the value of the annuities in the account balance on the valuation date in the preceding year before dividing the account balance by the applicable distribution period. (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 204.) See Chapter 8 of the treatise.

Reduction of Penalty for Failure to Make Required Minimum Distributions. – After 2022, the penalty for failure to make required minimum distributions is decreased from 50 percent of the undistributed amount to 25 percent. The penalty may be further reduced to 10 percent if failure to take a required minimum distribution is timely corrected. (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 302.) See Chapter 8 of the treatise.

Conformance of Treatment of RMDs from Designated Accounts to the Treatment of Roth IRAs. – After 2023, minimum distributions from a designated Roth account are not required during the lifetime of the participant. This change conforms the minimum distribution treatment of designated Roth accounts to the treatment of Roth IRAs. (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 325.) See Chapter 8 of the treatise.

Surviving Spouse’s Election to Be Treated as the Employee in an Employer Plan. – The regulations have long allowed a surviving spouse to elect ownership of a deceased spouse’s IRA if the spouse is the sole beneficiary of the IRA. Now, for years after 2023, Congress has granted a similar election to surviving spouses who are the sole beneficiary of a retiree’s interest in an employer plan. (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 327.) See Chapter 8 of the treatise.

Ten-Year Deferral, and Fewer Life Expectancy Distributions, for Designated Beneficiaries. – The SECURE Act of 2019 has completely revamped the taxation of required minimum distributions made to designated beneficiaries of tax-favored plans for beneficiaries of retirees dying after 2019. Plans may now make distributions over the life expectancy of a beneficiary only if the beneficiary is an “eligible designated beneficiary” (EDB). EDBs are limited to (1) the surviving spouse of the retiree, (2) a minor child of the retiree, (3) a disabled individual, (4) a chronically ill individual, or (5) an individual who is not more than ten years younger the retiree. Designated beneficiaries who are not EDBs must take distribution of the entire plan benefit by the end of the tenth year following the death of the taxpayer. An EDB may also choose the ten-year limit in lieu of the life expectancy distribution. (IRC § 401(a)(9)(H); the SECURE Act of 2019, Pub. L. No. 116-94, § 401(a).) See Chapter 8 of the treatise.

New Limitations on Distributions to See-Through Trusts for Retirees Dying after 2019. – If a trust is one of the beneficiaries of a tax-favored plan, the tax law generally treats the plan as having no designated beneficiary for purposes of making required minimum distributions. A plan or arrangement without designated beneficiaries generally may not defer taxes for as long a period. However, for retirees dying before 2020 there was a significant exception for so-called “see-through” trusts. If all the beneficiaries of the see-through trust were designated beneficiaries, the plan or IRA could make distributions to the trust over the life expectancy of the oldest beneficiary. Unfortunately, for retirees dying after 2019, a plan may make such life expectancy distributions to a see-through trust only if all the beneficiaries of the trust are eligible designated beneficiaries (EBDs), as described in the item immediately above. (IRC § 401(a)(9)(H); the SECURE Act of 2019, Pub. L. No. 116-94, § 401(a).) See Chapter 8 of the treatise.

Applicable Multi-Beneficiary Trust for Disabled or Chronically Ill Beneficiaries. – An “applicable multi-beneficiary trust” (AMBT) is a trust with two or more beneficiaries, all of whom are treated as designated beneficiaries, and at least one of whom qualifies as an eligible designated beneficiary (EDB) because he or she is disabled or chronically ill. For beneficiaries of retirees dying after 2019, the Code now provides a safe harbor for the separation of an AMBT into separate trusts, to allow distributions to disabled or chronically ill EBDs under the life expectancy rule. Alternatively, if no beneficiary of an AMBT other than disabled or chronically ill EDBs has any right to plan benefits until the death of all the disabled or chronically ill EDBs, the plan may make distributions to the trust under the life expectancy rule, without separating the trust. (IRC § 401(a)(9)(H); the SECURE Act of 2019, Pub. L. No. 116-94, § 401(a).) See Chapter 8 of the treatise.

Minimum Distribution Flexibility for Certain Government Plans. –  Proposed regulations indicate that qualified governmental plans and eligible state/local plans have more latitude in complying with minimum distribution requirements than other types of plans. The proposed regulations treat these government plans as satisfying minimum distribution requirements if the plans comply with a reasonable and good faith interpretation of the Code – apparently, even if that interpretation is contrary to regulatory provisions. (Prop. Reg. § 1.401(a)(9)-1, Q&A 2(d).) See Chapter 8 of the treatise for minimum distribution requirements.

Beneficiary Designation by Judicial Reformation. – Beneficiaries of tax-favored retirement plans qualifying as “designated beneficiaries” may be eligible for longer distribution periods than other beneficiaries. However, a retiree may fail to properly name a designated beneficiary. In a private ruling, the IRS allowed an individual to become a designated beneficiary by reason of a state court reformation of a beneficiary designation form, at least where convincing evidence indicated that was consistent with the retiree’s original intention. However, in a more recent ruling, the IRS refused to recognize a trust reformation that attempted to eliminate non-individual beneficiaries of an IRA and thereby allow the post-mortem “creation” of designated beneficiaries. (Ltr. Ruls. 200616039 and 201021038.) See Chapter 8 of the treatise for a discussion of designated beneficiaries.

Separate Accounts Unavailable When Beneficiary Is a Decedent’s Estate. –Beneficiaries of a decedent’s estate may not treat as separate accounts their interests in a plan or inherited IRA held by them indirectly through the estate. “See through” rules do not apply to an estate. Thus, required minimum distribution rules are applied to such a plan or inherited IRA as a whole. The minimum distribution rules are applied in the aggregate even if funds in the plan or inherited IRA are directly transferred to several new inherited IRAs, each for the benefit of an individual beneficiary of the estate. (Ltr. Rul. 201128036.) See Chapter 8 of the treatise.

Non-Spouse’s Minimum Distribution Election Under Personally Purchased Annuity. – The tax law requires that a non-spouse beneficiary receive minimum distributions under a personally purchased annuity contract. However, the IRS has ruled that those minimum distribution requirements may be satisfied if a non-spouse beneficiary merely elects to be treated for tax purposes as if he or she had received the entire value of the annuity contract as of the retiree’s death. (Ltr. Rul. 201302015.) See Chapter 16 of the treatise for a discussion of personally purchased annuities.

Deaths of Decedent and Surviving Spouse in Quick Succession. – A retiree and his or her surviving spouse may both die within a short period of time, with the longer living spouse being the designated beneficiary of the retiree’s IRA. In that case, a disclaimer of the IRA by the executor of the now deceased surviving spouse may allow IRA distributions over the life expectancy of a younger successor beneficiary (e.g., their son) rather than the shorter life expectancy of the surviving spouse. However, the life expectancy distribution would be available only if the successor beneficiary qualified as an “eligible” designated beneficiary (i.e., the son was a minor, disabled, or chronically ill). (IRC § 401(a)(9)(H); Ltr. Rul. 201202042.) See Chapters 8 and 20 of the treatise for a discussion of disclaimers and minimum distributions.

Delayed Minimum Distribution Payments. – Tax-favored plans and arrangements generally must begin making minimum distributions to a retiree or beneficiary by a specified date. The IRS cannot  waive a delay in the making of a payment. However, the IRS may waive a penalty resulting from the delay if the delay was due to reasonable error that the retiree or beneficiary is taking reasonable steps to correct. (Ltr. Rul. 201417027.) See Chapter 8 of the treatise.

Purchase of Qualifying Longevity Annuity Contracts (QLACs). – New regulations authorize “qualifying longevity annuity contracts” (QLACs) that provide additional tax deferral for certain retirement plans and IRAs. The regulations allow deferral of QLAC payments until an advanced age. In addition, earlier required minimum distributions are necessarily smaller because the regulations exclude the value of QLACs from the account balance used to compute minimum distributions. Perhaps most importantly, QLACs provide some additional financial security for participants who outlive their life expectancies or suffer downturns in the equity markets.

A QLAC may be purchased for a plan participant by a qualified defined contribution plan, an eligible state/local government plan, or an IRA (other than a Roth IRA). A QLAC may start no later than the first day of the month after the participant attains age 85. The aggregate premiums for all QLACs benefiting a participant may not exceed certain dollar and percentage limitations. The QLAC must also satisfy all the usual minimum distribution requirements for annuities (other than starting by the required beginning date). (Treas. Reg. § 1.401(a)(9)-6, Q&A 17.) See Chapter 8 of the treatise.

New Life Expectancy Tables and a New Uniform Lifetime Table. – New life expectancy tables and a new Uniform Lifetime Table providing longer distribution periods apply for required minimum distribution purposes for calendar years beginning after 2021. Furthermore, if a post-2021 minimum distribution to a nonspouse beneficiary is required to be determined by reference to a life expectancy initially determined for a year before 2022, that life expectancy is redetermined under the new tables as if the new tables were effective for the pre-2022 year of initial determination. The new life expectancy period is then reduced by one for each year elapsed since the pre-2022 year of the initial determination. For a surviving spouse, however, the distribution period is determined anew under the new tables for each distribution year after 2021. (Treas. Reg. § 1.401(a)(9)-9.) See the Appendix to the treatise.

The new tables also apply to the safe harbor methods for computing substantially equal periodic payments that avoid the penalty on premature distributions from IRAs, retirement plans, and commercial annuities. However, the new tables are generally not applicable until years after 2022 for this purpose. Nevertheless, taxpayers have the option to use the new tables for substantially equal payments beginning in 2022. Furthermore, in any year after 2021, taxpayers may change to the new tables even if substantially equal payments commenced before 2022. (Rev. Rul. 2022-6, 2002-5 I.R.B. ___.)

Suspension of Minimum Distribution Requirements for 2020. – Congress has eliminated minimum distribution requirements for 2020 for tax-favored plans that are individual account plans (i.e., are not defined benefit plans). Thus, a retiree who chooses to take distributions in 2020 from such a tax-favored plan may roll over even the portion that would have been a required minimum distribution absent the suspension of the requirement. Although the plan is not required to make trustee-to-trustee transfers of such amounts, it may do so if it chooses. In addition, the direct distribution of such amounts to a retiree by the plan is not subject to the normal 20 percent tax withholding, and the retiree may elect to eliminate other types of withholding tax.

In addition, a retiree whose required beginning date (RBD) is April 1, 2020 need not take a minimum distribution for 2019, unless the retiree already did so in 2019. After 2020, the retiree’s RBD must be determined in the usual way without regard to the 2020 suspension. The retiree’s beneficiary must also use the retiree’s normal RBD to determine the applicable method for determining minimum distributions. In addition, if the five-year minimum distribution rule applies to a beneficiary, the beneficiary does not count 2020 as one of the five years. For example, the five-year period ends in 2023, instead of 2022, for a retiree who died in 2017. The new ten-year distribution period for designated beneficiaries is unchanged. (I.R.C. §§ 401(a)(9)(I), 402(c)(4).) See Chapter 8 of the treatise for a discussion of required minimum distributions.