By S. Derrin Watson, JD, APM

The Internal Revenue Service (“IRS”) issued some welcome relief in connection with the required minimum distribution (“RMD”) rules. The transition relief impacts both certain RMDs erroneously paid out at the beginning of 2023, as well as some RMDs that, according to the IRS proposed regulations, need to be made this year.

Background

Internal Revenue Code (“Code”) §401(a)(9)(H), as added by the SECURE Act of 2019 (“SECURE”), limited the duration of many RMDs to beneficiaries to 10 years after death. This limitation applies to defined contribution plans (including 403(b) and 457(b) plans) and IRAs. For most plans, the new limitation on beneficiary distributions applied to deaths after December 31, 2019.  For governmental plans and many collectively bargained plans, the new limitation was effective for deaths after December 31, 2021. For convenience, we will call the applicable effective date “the SECURE Effective Date.”

In February 2022, the IRS issued detailed proposed regulations addressing the new RMD rules. Under the proposal, the regulations, once finalized, would be effective January 1, 2022, and a reasonable, good faith interpretation of SECURE would suffice for 2021. In particular, the proposed regulations on the application of the 10-year rule were controversial.

As a result of the controversy, the IRS announced that the effective date of the proposed regulations would be no sooner than January 1, 2023, and provided transition relief for 2021 and 2022 for certain beneficiaries of deceased participants. [Notice 2022-53]

Congress modified the RMD rules in the SECURE 2.0 Act of 2022 (“SECURE 2.0”), which the President signed December 29, 2022.  Among these changes was a delay in the Required Beginning Date (RBD).  Individuals born in 1951 turn 72 in 2023, and under the rules before SECURE 2.0, would generally have had an RBD of April 1, 2024. SECURE 2.0 changed the RMD age to 73, resulting in a one-year delay in RMDs for individuals born after 1950.

Unfortunately, this resulted in a situation where, as it were, the reprieve from the governor came after the warden had pulled the switch.  Acting on the law in effect before SECURE 2.0, many automatic systems at financial institutions began generating RMD distributions to people born in 1951 based on the RMD rules before SECURE 2.0. Plans treated these distributions as not being eligible rollover distributions (as is the case for RMD distributions). Additionally, IRA owners began withdrawing anticipated RMDs from their IRAs.

With the changes under SECURE 2.0, there are two issues:

1. There is no mandatory distribution due to those born in 1951, so, unless the plan provides otherwise, the distributions violated the plan’s terms.
2. If there were a permitted or mandatory distribution to those born in 1951, it would not be an RMD, so it would usually be an eligible rollover distribution.  Therefore, the distributing plan would potentially have operational failures because it neither provided a special tax notice nor allowed the participant to make a direct rollover, and it did not apply the mandatory 20% withholding which the law mandates for eligible rollover distributions.

New Guidance

The IRS released Notice 2023-54 (the “Notice”) on July 14, 2023, addressing these issues.  The Notice does three things:

1. Delay in regulatory effective date
   
   The Notice announces that the RMD regulations, when finalized, will not be effective before January 1, 2024. The delay is understandable given the many changes SECURE 2.0 made to the RMD rules. At this point, it is too soon to speculate whether that means the IRS will issue the final regulations this year, and what impact the delay may have on upcoming Cycle 4 defined contribution plans.
   
   
2. Rollover relief for RMDs paid to individuals born in 1951
   
   If an individual born in 1951 received a plan distribution thought to be an RMD between January 1 and July 31, 2023 (which is, in fact, not an RMD because of SECURE 2.0 changes), the Notice provides that the individual has until September 30, 2023, to roll the money over. This is an extension of the normal 60-day rollover period.  Further, plans are not penalized for having failed to treat these distributions as eligible rollover distributions.
   
   This rollover relief for individuals born in 1951 also applies to RMD withdrawals from IRAs taken by July 31, 2023.  The deadline to roll over these distributions is also extended to September 30, 2023. IRA owners can roll over the distributions even if they had another IRA rollover in the prior 12 months, although the individual will not be able to make another indirect rollover from one IRA to another during the 12-month period following the rollover. [Code §408(d)(3)(B)]
   
   Example:  Paula was born April 15, 1951. She and the administrators of her 401(k) plan thought her RBD would be April 1, 2024, and, accordingly, informed her that she would need to take a $15,000 RMD in relation to 2023.  Paula said, “Fine, but let’s take out another $10,000 as well.”  So the plan distributed $23,000 to Paula in January 2023 (after withholding 20% on the extra $10,000, which the plan treated – correctly – as an eligible rollover distribution). Because of the Notice, Paula can roll over the $15,000 to an IRA (or back to the plan) prior to October 1, 2023.
   
   Example: Irvin was born in 1951.  His IRA custodian sent him a notice in early January that he would need to withdraw a $10,000 RMD from his IRA before April 1, 2024.  He made the withdrawal on February 15, 2023.  He can roll the money back into the IRA (or into any other appropriate rollover vehicle) any time prior to October 1, 2023.  If he rolls the funds into an IRA, he will be barred from making additional indirect IRA rollovers for one year beginning on the date of the rollover.
3. Extension of transition relief
   
   The Notice extends for one year the transition relief provided in Notice 2022-53.  Under this extension, a plan will not have a failure because it did not distribute a “specified RMD” and the beneficiary will not be subject to excise (penalty) tax for failure to take a specified RMD.  In short, a specified RMD is a 2023 RMD to certain beneficiaries of deceased participants.  More precisely, there are two sets of specified RMDs:
   • Set 1: An RMD is a specified RMD if it meets all of the following conditions:
     • The RMD is a life expectancy payment due (under the proposed regulations) from a defined contribution plan or an IRA in 2023.
     • The RMD is due to a designated beneficiary following the death of a participant.
     • The participant died:
       • In 2020, 2021, or 2022
       • After the SECURE Effective Date, and
       • On or after the participant’s RBD.
     • The designated beneficiary is not taking life expectancy distributions (but should be under the proposed regulations).

   • Set 2:  An RMD is a specified RMD if it meets all of the following conditions:
     • The RMD is a life expectancy payment due (under the proposed regulations) from a defined contribution plan or an IRA in 2023.
     • The RMD is due to a successor beneficiary of an eligible designated beneficiary. For this purpose, an eligible designated beneficiary includes a designated beneficiary of a participant who died before the SECURE Effective Date.
     • The eligible designated beneficiary died in 2020, 2021, or 2022 and after the SECURE Effective Date.

Notice 2022-53 provided the same relief for distributions that should have been made in 2021 or 2022.

Example:  Betty died in 2020 after her RBD, leaving her profit-sharing plan balance to her son, Alan. Alan is not an eligible designated beneficiary. Alan took Betty’s 2020 RMD after her death, but did not take 2021, 2022, or 2023 RMDs. The plan does not have an operational failure as a result of the failure to distribute, and Alan is not subject to an excise tax.

Example: Adam died in 2018, leaving his IRA in trust to his son, Seth. Seth begins taking life expectancy distributions. Seth dies in 2020, leaving his balance to his son, Jared. Seth took his 2020 RMD before his death. Under the proposed regulations, Jared is required to continue taking life expectancy RMDs (based on Seth’s life) with a final distribution on December 31, 2030. Jared did not take the 2021, 2022, or 2023 RMDs. Jared is not subject to the excise tax.

What Happens Next?

Participants born in 1951 now have the opportunity to roll over distributions made between January 1 and July 31, 2023, which were originally mischaracterized as RMDs and hence ineligible for rollover. The rollover may be made to an IRA, but nothing in the law prohibits the participant from rolling the funds back into the distributing plan, particularly if the participant is a working owner.

The Notice allows plans to be administered safely for 2023, knowing that, if the plan does not distribute “specified RMDs,” neither the plan nor the beneficiary will be penalized. We don’t know yet whether the final regulations will require a “make-up” distribution of the 2021 though 2023 specified RMDs as part of the 2024 RMD.  We also don’t know if final regulations will follow the proposed regulations on this or other issues.

If you have any questions about the Notice or the RMD rules, give us a call.  After all, we are your ERISA solution!

Look for Derrin’s upcoming title, Plan Distribution eSource, coming soon from ERISApedia.  This comprehensive work will cover the RMD and other distribution rules and restrictions, a timely topic in light of the recent Congressional expansion and changes in the distribution rules.

Ilene and Derrin will discuss these changes and more at the FIS Advanced Pension Conference, September 6 – 8, 2023 in Chicago.