Ed Slott: New IRS Secure Act Regs Are an RMD ‘Nightmare’

The Internal Revenue Service’s recently released proposed regulations about how to handle required minimum distributions under the Setting Every Community Up for Retirement Enhancement (Secure) Act of 2019 are a retirement planning nightmare, according to IRA and tax planning expert Ed Slott of Ed Slott & Co.

The 10-year rule under Secure, which was passed at the end of 2019, establishes a 10-year time period for the “full” distribution of an inherited IRA, but only for deaths occurring after 2019 and not for all beneficiaries.

The new proposed regs turn the 10-year rule into a “retirement planning nightmare for both advisors and clients!” Slott told ThinkAdvisor Monday in an email.

The IRS proposal “took something that was actually getting somewhat simplified and made it much more complex,” Slott said.

IRS' Secure Act Guidance on RMDs Has a Surprise Twist

Right now, he continued, “we are rewriting all of our advisor IRA training and workshop manuals, and inserting all of these new provisions. It’s now a real mishmash of complexity, combining some old rules (which we thought no longer applied) with new ones.”

As Slott explained in a previous interview with ThinkAdvisor, the Secure Act “left many open questions” when it was enacted in 2020.

After more than two years, “these proposed regulations provide our first glimpse into the answers to most of the open RMD questions” after the Secure Act, Slott said.

“I really don’t know how advisors will be able to explain this all to clients, especially right after they have spent two years learning the Secure Act rules, explaining them to affected clients and then doing planning based on how they believed the post-death RMD rules would work,” Slott said Monday. “There are even added rules that affect 90 +-year-olds.”

Huge Penalties

The real problem: “these provisions affect virtually everyone with a retirement account, IRAs, 401(k)s, everything, and the penalties for missing an RMD are 50%.”

Th new “labyrinth of confusing rules,” Slott continued, “will fall not only on the clients in setting up their IRA estate plans but specifically on their beneficiaries who first must figure out — what kind of beneficiary am I?”

Even thornier: “When a trust is the beneficiary, which affects many clients with large IRAs, who tend to leave those IRAs to trusts,” Slott said. “These trusts will now have to be reviewed to see if they will still hold up and meet the client’s intended estate plan. They probably won’t.”

Under the Secure Act, Slott explains, when a beneficiary inherits they can fall into one of three groups:

1. Non-designated beneficiary (NDB) not a person.

Examples are an estate, charity or non-qualifying trust.

“These rules have not changed but this is the worst category of beneficiary, for RMD payout purposes,” Slott said. “This generally applies when a person neglects to name a beneficiary or a beneficiary has died, and the beneficiary form was not updated.”

2. Designated beneficiary — but not an EDB.

These are beneficiaries who will no longer qualify for the stretch IRA (most older children, grandchildren and other non-spouse beneficiaries) and will end up with the 10-year rule (all inherited funds must be withdrawn by the end of the 10th year after death).

3.  Eligible designated beneficiary (EDB).

These are surviving spouses and a few other beneficiary categories:

• Minor children of the deceased IRA owner (up to age 21, regardless of state law), but not grandchildren;
• Disabled or chronically ill beneficiaries; and
• Beneficiaries who are not more than 10 years younger than the deceased IRA owner.

These EDBs still qualify for the stretch IRA.

Biggest Surprise: The 10-Year Rule

The biggest surprise under the new IRS RMD proposed regs “is their interpretation of the 10-year rule,” Slott continued.

“For two years we all thought that OK, Congress did away with the stretch IRA for most non-spouse beneficiaries and replaced it with a 10-year rule requiring all the inherited funds to be withdrawn by the end of the 10-year term,” Slott said.

“That actually made things much simpler since there was generally no need any more to calculate RMDs, identify beneficiaries to determine the measuring life, or to know which rules applied based on when death occurred (either before or after the required beginning date — the RBD),” he said.

The regs, however, “now bring back that original RMD complexity and add it to the 10-year rule, creating new layers of planning to determine the post-death RMD payouts to beneficiaries.”

The rules are effective now, Slott said, “and could possibly even affect 2021 RMDs that should have been taken but weren’t because no one thought they were required.”

The IRS will hopefully provide relief on this point, he said.

Payouts Now Under 10-Year Rule

Under the regs’ 10-year rule, to determine the payouts to beneficiaries, “you first must know when the IRA owner died,” Slott explained.

“If death was before the required beginning date (RBD) then no annual RMDs are required. The only RMD would be at the end of the 10-year term when the full balance of the inherited IRA must be withdrawn,” he said.

If death occurs “on or after the RBD, then annual RMDs are required for years 1-9, based on the regular stretch IRA rules, and then again, the full balance of the inherited IRA must be withdrawn by the end of the 10-year term,” Slott explains.

“This means that we must go back to calculate relatively small RMDs for years 1-9, which brings in more complexity especially when there are multiple beneficiaries with different life expectancies.”

Different Rules for Roth IRA and Traditional IRA Beneficiaries

Roth IRA owners “will always be deemed to have died before their RBD (regardless of their age at death) since Roth IRAs have no lifetime RMDs,” Slott said. “Roth IRA inheritors will not have to take RMDs for years 1-9, like other IRA beneficiaries might.”

The 10-year rule RMD interpretation “carries the confusion over to successor beneficiaries (after the beneficiary dies), who also may be subject to RMDs base on the original beneficiary’s life if the original beneficiary died before the 10-year term expired, and if that beneficiary inherited from an IRA owner who died after his RBD,” Slott explained. “Who is going to keep track of all these key dates and rules?”

These rules will also apply to trust beneficiaries which can mean RMDs for years 1-9 that would have to be paid out to trusts, and which could (depending on the type of trust) be taxable at high trust tax rates each year.

There are also new rules for multiple beneficiaries (when one beneficiary for example is an EDB and the other is not) and for trusts, which are generally favorable to the beneficiaries if they can navigate the rules.

While surviving spouses were thought to be generally unscathed by all these rules, since they are EDBs, it turns out that the regulations also affect them.

‘Bizarre’ New RMD Term

The IRS created an “incredulous new term ‘hypothetical required minimum distributions’ to make sure that certain spouses who elected the 10-year rule don’t avoid RMDs that would otherwise have had to be taken when that spouse hit RMD age — 72,” Slott explained.

“This one is bizarre.”

These “hypothetical” RMDs “are not really RMDs that must be taken, but additional annual RMD calculations will have to be made each year to determine how of much of the IRA that the spouse inherited from his/her spouse can be rolled over in a spousal rollover, since RMDs cannot be rolled over,” Slott said.

The IRS considers these “hypothetical” RMDs “as funds that cannot be rolled over in spousal rollover. Yearly calculations will have to be made to determine how much of the IRA the spouse inherited from his or her spouse can be rolled over as a spousal rollover.”