RETIREMENT PLAN ALERT: Proposed Regulations Would Affect Inheritance of Retirement Accounts
By Attorney James A. Spella, Schloemer Law Firm, S.C.
The IRS has proposed regulations that affect the distributions from retirement plans. Though the proposed regulations are not ‘final’, when they do become ‘final’, they will be effective January 1, 2022. Public comments can be made through May 25, 2022, followed by a public hearing scheduled for June 15, 2022.
The proposed regulations address in large part ‘required minimum distributions’, referred to as “RMDs”. The proposed regulations have been issued to provide clarification of the 2019 SECURE Act, which accelerated the time period over which RMDs needed to be paid to the participant/beneficiary who inherited a retirement account. Accordingly, the ability to defer income recognition and maximize tax free accumulation during the deferral was reduced for beneficiaries.
Prior to the Secure Act, a beneficiary was allowed to receive RMDs based on the beneficiary’s life expectancy. After the SECURE Act, and except for the participant and participant’s spouse and a few other special circumstances, this was limited to no more than 10 years, thus accelerating taxes.
The proposed regulations further impact the advantages of deferral. The Secure Act eliminated life expectancy payouts, but allowed for a 10-year payout, but did not mandate annual distributions in years 1-9. Accordingly, a beneficiary could defer all distributions until the 10th year.
The proposed regulations to the Secure Act prohibit this 10-year deferral and require income recognition in years 1-9 based on a life expectancy, with the balance being paid by the 10th year. By not providing the taxpayer benefit of deferral, income recognition and taxation are accelerated.
Example: Under the existing Secure Act, prior to the new proposed regulations, if a father designates an adult, non-disabled son as a beneficiary, the son was allowed to receive RMDs over a 10-year period with no mandate to take annual distributions. Accordingly, the son could defer receipt of the plan assets until the last day of the 10th year.
Under the proposed regulations, the son would be required to receive annual payments in years 1-9 based on the son’s life expectancy, and then in the 10th year receive the balance.
Proposed Regulations & Distribution Rules
Distribution rules differ dependent on the designation of the beneficiary:
Eligible Designated Beneficiary (EDB) – Surviving Spouse
Eligible Designated Beneficiary (EDB) – Minor Child
Eligible Designated Beneficiary (EDB) – Disabled – Chronically Ill
Designated Beneficiary (DB) – Not an EDB, and not a Non-EDB; (i.e., children are typically DB’s unless they are minors or disabled)
Non-DB Employee’s Estate
To further complicate matters, the rules also differ depending on whether you die before or after your “Required Beginning Date” (RBD). The RBD is the latest date to which a plan can let a participant defer starting distributions. The SECURE Act previously increased the RBD triggering age from 70-1/2 to 72, so the RBD will depend upon when the plan participant passed away.
These different distribution rules can dramatically impact the value of the qualified assets for family members.
For example: If a surviving spouse names his/her children as beneficiaries, the beneficiaries as DBs will be subject to the new 10-year rule
If a surviving spouse would name his/her estate which then distributes to the children, the estate is a Non-DB, and the distributions would be taken over the life expectancy of the deceased surviving spouse.
Gets complicated? You bet.
And this does not even address the new rules that impact having a trust named as a beneficiary.
What does this mean to you?
First, decide who you want to name as a beneficiary under your qualified plans, for both primary and contingent beneficiaries.
Second: Make such designations after reviewing the distribution rules that will be in effect, and what alternatives you could have selected.
Caveat: Do not let the ‘tax tail, wag the dog’. A plan that reduces taxes does not always best obtain you’re your objectives. Have your beneficiary designations meet your planning objectives?
A significant portion of an individual’s estate is often qualified plan assets, i.e., retirement accounts. As part of an individual’s estate plan, these assets are distributed in accordance with the beneficiary designations made with the plan administrator, and generally not by what a Will or Living Trust will provide. So thoughtful beneficiary designation planning should be reviewed on a periodic basis, along with your other estate planning documents.
If you have questions about this article, please contact this article’s author or one of our estate planning attorneys at [email protected] or 262-334-3471.
Originally published: April 5, 2022.
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Disclaimer: The information contained in this post is for general informational purposes only and is not legal advice. Due to the rapidly changing nature of law, Schloemer Law Firm makes no warranty or guarantee concerning the accuracy or completeness of this content. You should consult with an attorney to review the current status of the law and how it applies to your unique circumstances before deciding to take—or refrain from taking—any action. If you need legal guidance, please contact us at 262-334-3471 or [email protected]