FLASHPOINT: RELIEF FOR SOME RMDS FOR 2021 AND 2022 – OR “HOW COMPLEX CAN WE MAKE THIS?”

The IRS issued some welcome relief to address the confusion many financial institutions and practitioners had about required minimum distributions (RMDs) under Internal Revenue Code (“Code”) §401(a)(9) after SECURE. IRS Notice 2022-53 forgives the failure of defined contributions plans and IRAs to distribute certain “specified RMDs” for 2021 and 2022 to beneficiaries, although there’s more to it than that.

SECURE Act Changes; Proposed Regulations

The SECURE Act made two important changes to the RMD rules.

1. It changed the required beginning date (RBD): now generally April 1 of the calendar year following the calendar year the participant attains age 72.
2. More importantly, it added Code §401(a)(9)(H), which 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. We published a detailed FlashPoint on March 3 explaining the treatment of beneficiary RMDs under the proposed regulations.

New Guidance

The IRS released Notice 2022-53 (the “Notice”) on October 7, 2022. The Notice announced that the proposed regulations, when finalized, will not be effective before January 1, 2023. But, more importantly, the Notice gives comfort to many who interpreted SECURE differently than the proposed regulations do.

The primary source of confusion relates to certain beneficiaries of participants who died after the SECURE Effective Date and on or after their RBD.  SECURE classifies beneficiaries into several broad categories:

• Designated beneficiaries (individuals), which fall into two categories:
  • Eligible Designated Beneficiaries (EDBs), which includes spouses, minor children, disabled persons, chronically ill individuals, and individuals no more than 10 years younger than the participant.
  • Designated beneficiaries that are not EDBs. For convenience, we will call these beneficiaries Other Designated Beneficiaries (ODBs).
• Other recipients that are not individuals (such as charities and estates, and trusts that do not qualify as “see-through” trusts).

Once an individual reaches his or her RBD, the individual must begin taking RMDs.  The proposed regulations hold that all categories of beneficiaries must continue taking RMDs, using the single life table, for each year after the participant’s death, until the account is completely distributed.  Under the SECURE limitation, ODBs must take the balance of the account no later than December 31 of the year containing the 10^th anniversary of the participant’s death.

Example:  Eve participates in her employer’s 401(k) plan. Her RBD was in 2015, and she has been receiving RMDs.  She dies in 2020, after the SECURE Effective Date.  Her beneficiary is her daughter, Abby, an ODB. If the plan hadn’t paid Eve her 2020 RMD before she died, the plan pays it to Abby.  Under the proposed regulations, Abby begins receiving RMDs in 2021 under the single life table, based on her life expectancy in that year. The plan must distribute the entire balance of the account to Abby by no later than December 31, 2030.

Many practitioners and financial institutions read SECURE differently.  They thought that there was no need to make annual distributions to ODBs even if the participant died after the RBD.  It was sufficient if the plan distributed 100% of the account by the year of the 10^th anniversary of the participant’s death.  (In fact, that is the requirement, sometimes called the “10-year rule,” for participants who die before the SECURE Effective Date.)

Example:  Under this interpretation of the rules, there would be no need to pay RMDs to Abby for 2021 through 2029.  The plan could simply distribute the balance of the account in 2030 and be done with it. Accordingly, her plan did not make any distribution to her in 2021.

Plan administrators who interpreted the rules this way were shocked to read the proposed regulations and find there was a potential operational failure for not having made a 2021 RMD to a beneficiary of a participant who died after the SECURE Effective Date and after the RBD.  The affected beneficiaries were similarly horrified to realize that they might be subject to a 50% penalty tax [Code §4974] for failure to take the RMD. Neither knew what to do for 2022 prior to issuance of final IRS guidance.

The Notice gives relief on both fronts.  The Notice provides that, for 2021 and 2022, there is no operational failure and no penalty tax for failure to pay “specified RMDs”.  If someone has already paid the penalty tax, they can file for a refund.  (However, if a beneficiary has already taken the 2021 or 2022 RMD, they cannot pay it back to the plan or roll it over to an IRA.)

The definition of “specified RMD” is tailored to address this situation (and one other, described below).  A 2021 or 2022 RMD is a specified RMD qualifying for this relief if it meets all of the following conditions:

• The RMD is a life expectancy payment due from a defined contribution plan or an IRA.
• The RMD is due to a designated beneficiary following the death of a participant.
• The participant died in 2020 or 2021, after the SECURE Effective Date, and after the participant’s RBD.
• The designated beneficiary is not taking life expectancy distributions.

There is one additional category of distributions that qualifies for the relief.  Under SECURE, if an EDB dies, the entire account must be paid to the EDB’s beneficiary (i.e., the “successor beneficiary”) by December 31 of the 10^th anniversary of the EDB’s death.  However, if the EDB was taking life expectancy distributions, they continue to the successor beneficiary in the meantime.  For this purpose, the designated beneficiary of a participant who died before the SECURE Effective Date is an EDB, and distributions to the successor beneficiary are subject to the 10-year cutoff if the EDB died after the SECURE Effective Date.

With this in mind, the Notice designates a second category of “specified RMDs” that qualify for the relief.  A 2021 or 2022 RMD is a specified RMD if it meets all of the following conditions.

• The RMD is a life expectancy payment due from a defined contribution plan or an IRA.
• The RMD is due to a successor beneficiary of an EDB.
• The EDB died in 2020 or 2021 and after the SECURE Effective Date.
• The EDB was taking life expectancy rule distributions.

What Happens Next?

We are still waiting for the IRS to finalize the RMD regulations. Previous guidance [Notice 2022-33] suggests that they are targeting that release for 2023.  Practitioners and financial institutions hope that release comes early in the year so that computer and administrative systems can be programmed in a timely matter to handle the 2023 distribution calendar year. In the meantime, plans can be administered safely for 2022, 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 and 2022 specified RMDs as part of the 2023 RMD.  We don’t know if final regulations will follow the proposed regulations on this or other issues.  It is clear the Treasury has heeded the concerns of the pension community about the lack of clarity and is trying to provide guidance to be followed while the IRS crafts the final rules.

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