By Alison J. Cohen, Esq.

On July 19, 2024, the Internal Revenue Service (“IRS”) bestowed upon us two pieces of “light” (NOT!) reading on required minimum distributions (“RMDs”).  One was the final regulations (“Final Reg.”) to Internal Revenue Code (“Code”) § 401(a)(9) – only a mere 290 pages that completely revised the RMD regulations from earlier versions to take into account the changes from the Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE 1.0”).  This FlashPoint isn’t about that.  The other guidance was the proposed RMD Regulation (“Prop. Reg.”), which expounds on several of the components of the SECURE 2.0 Act of 2022 (“SECURE 2.0”) impacting RMDs.  That is the subject of this Flash.  Call me a wimp, but I preferred reading and digesting the 36-page Prop. Reg. first.

I will also share that, of all the areas of the Code, and all of the other regulations covering pensions, the area that I have come to abhor is RMDs.  If you are like me, you’ll agree that the rules have become so convoluted that you practically have to draw a flow chart every time you are asked to figure out a calculation and … if, heaven forbid, the participant died, then Venn diagrams may be required.  If any member of Congress reads this Flash, I beg you, please, talk to people in our industry and let’s get a new proposal implemented to simplify this mess.

Formal comments on the Prop. Reg. are due by September 17, 2024.

Here is what is discussed in the Prop. Reg. in relation to the SECURE 2.0 changes:

Section 107 – Updating the RMD Age. As you may recall, SECURE 2.0 provided for an incremental increase in the age at which lifetime RMDs must begin, which creates four different possible beginning ages (70½, 72, 73, or 75), based on the participant’s date of birth.  One small snafu: the law contained a logical glitch for the various dates, and it was unclear whether the beginning age for someone born in 1959 was 73 or 75.  The Prop. Reg. clarifies that the applicable age for folks born in 1959 is age 73.

Section 204 – Aggregation of Annuity Contracts for Calculation. It has been unclear as to how to satisfy Code § 401(a)(9) if an individual’s interest in a defined contribution plan is invested partially in an annuity contract and partially in general investments.  The Prop. Reg. clarifies that, to calculate the annual payment, the fair market value of the contract and the account balance are to be aggregated to determine the total value of the “account” as of December 31 of the year before the year for which the RMD is taken.  That value is used to calculate the amount of the RMD for that year, and the annuity payments are then applied to the RMD, thereby reducing the amount of the resulting RMD that must be taken from the general investments.

Section 325 – Distributions from Designated Roth Accounts. The Prop. Reg. fills in a gap in the Final Regulations relating to how distributions from Designated Roth Accounts are treated for purposes of RMD rules.  SECURE 2.0, Section 235 modified the Roth rules under Code section 402A(d) to provide that the RMD and incidental death benefit requirements do not apply to Designated Roth Accounts during the participant’s lifetime.  In other words, no RMDs are needed from amounts in the Designated Roth Account while the participant is alive (including for the year of the participant’s death).  This left open a question of whether a distribution from a Roth Account would nonetheless constitute an RMD if taken in a year when the lifetime RMD rules apply only to a non-Roth account.  The Prop. Reg. clarifies that distributions from Roth Accounts do not count for lifetime RMD purposes.  This means that, if a participant has both Roth money and non-Roth money in the plan, the full RMD must be taken from the non-Roth account each year.  On the plus side, this also means that any distribution from a Designated Roth Account during an RMD year while the participant is alive is an eligible rollover distribution, so it can be rolled to a Roth IRA, if it otherwise meets the requirements to be a rollover distribution.  (Take care, however:  if the Roth distribution is not a Qualified Distribution, the earnings portion of any amount not rolled over is subject to 20% mandatory withholding.)

Section 302(b) – Corrective RMDs and 4974 Excise Taxes. One of the most exciting parts of SECURE 2.0 was the reduction of the § 4974 excise tax (relating to a failure to take an RMD when due) from 50% to 25%.  A participant may further reduce this excise tax to 10% if: (a) a corrective distribution of the RMD and earnings is made by the end of the calendar year following the calendar year in which the RMD was due; and (b) the participant files the excise tax form (Form 5329) to the IRS and pays the 10% tax.

Additionally, an RMD is required for the year of the participant’s death.  If the participant hasn’t taken it before they died, then the beneficiary(s) must do so.  It is common that this payment is missed.  Therefore, if you are a beneficiary and neither you nor the deceased participant took their RMD for the year of death, you can get an automatic waiver of the excise tax if correction is made by the end of the year following the year of death. (And remember:  the beneficiary has an RMD of their own for that year, too, in addition to catching up on the RMD that is in arrears.)

Section 327(a) – Spousal Election. If an employee dies before the date on which RMDs are required to begin (called the “Required Beginning Date” or “RBD”), an eligible designated beneficiary is generally required to take distributions over either their lifetime (starting by the end of the year following the year of death) or within a 10-year period.  (Other designated beneficiaries are subject to the 10-year rule and beneficiaries that are not designated beneficiaries are subject to the 5-year rule.)  Spousal beneficiaries (if they are the sole beneficiary) are given special treatment.

First, the surviving spouse is treated as if they were the employee for purposes of calculating the RMD.  The Prop. Reg. clarifies that, if the employee dies before the RBD, this treatment is automatic.  If the employee dies after the RBD, the surviving spouse must affirmatively elect to be treated as the employee or the plan document must provide that the treatment is automatic.  The most important impact of this rule is that the surviving spouse is able to take distributions using the Uniform Lifetime Table (“ULT”), which permits a spread of distributions over a longer period than the single life table, which normally is used for beneficiaries.  The ULT rate that is used is the larger of the rate using the spouse’s age or the rate using the participant’s age.   It also permits the spouse to roll over the death benefit (minus the RMD for the year of death) to an IRA in their own name, rather than an inherited IRA, permitting the spouse to take distributions based on their own RBD.

Second, if the spouse is taking a life expectancy distribution, then payments don’t need to begin until the 12/31 of the year during which the participant would have attained their RMD Age.  As noted above, these life expectancy distributions are determined using the ULT.

The final advantage is that, if the surviving spouse dies before distributions begin, then the beneficiaries of the spouse are treated as if the spouse was the participant.  This gives them all the options available to beneficiaries of deceased participants.  The only exception is that, if the surviving spouse has since remarried, the new spouse is not treated as a surviving spouse beneficiary (but is an eligible designated beneficiary).

Section 202(a)(3) – Divorce after QLAC. Suppose a participant purchases a qualifying longevity annuity contract (“QLAC”) with joint and survivor annuity benefits for the participant and their then-spouse. Suppose further that the two spouses subsequently get a divorce before the annuity payments commence.  Under SECURE 2.0, the joint and survivor benefits are still permissible if there is a qualified domestic relations order (“QDRO”) that generally provides for the former spouse to be the surviving spouse under the contract.  SECURE 2.0 also provides that a divorce or separate instrument can be used in place of an actual QDRO.  The Prop. Reg. clarifies that these other instruments are able to be used in lieu of a QDRO only for plans not subject to the QDRO rules of ERISA section 206(d) and the Code section 414(p)–particularly, governmental plans.  The Prop. Reg. also better defines what alternative documents may be used for this purpose.

See-Through Trust Distribution Rules. As mentioned earlier, Treasury also published the finalized Regulations (“Final Reg.”) that were originally proposed in 2022 before SECURE 2.0 came into being.  The Final Reg. contains detailed rules relating to the impact on the RMD rules if a trust is the beneficiary of retirement plan death benefits.  The Prop. Reg. contains a clarification of how the rules apply when there is an outright distribution to a trust beneficiary from a see-through trust.  The example given to explain this rule is the best illustration:  “If a trust which is a named beneficiary provides that each of three children have equal interests in the portion of the trust attributable to the employee’s interest in the plan, and the trust provides that it is to be immediately divided upon the death of the employee, then section 401(a)(9) is permitted to be applied separately with respect to the separate interests of the three children, even if the separate interest of one of the children is held by a sub-trust while the separate interests of the other children are held directly by those children.”  (Sorry, Professor Hirsch. I still hate trusts!)

When does all this goodness go into effect?  On or after January 1, 2025, which is just a minute away.  With comments due September 17, and a hearing scheduled for September 25, 2024, it will be a tight squeeze for the IRS to get this finalized in time for the 2025 effective date, given everything else that we know is still pending.  I wouldn’t hold your breath for final Regulations to come out before the end of this year.  For years prior to 2025, a reasonable, good faith interpretation of both the Final Reg. and SECURE 2.0 should be used.  The rules of the Prop. Reg. are deemed to be a reasonable, good faith interpretation.

Stay tuned for more RMD discussions.  And remember, when you have questions and can’t figure out how to apply the rules – we are your ERISA solution!