The Final RMD Rules Are In: Here’s What You Need to Know

Attention all retirement account owners and beneficiaries of inherited accounts (and that’s just about everybody):

The IRS issued its final regulations on Required Minimum Distributions, which can be a critical part of any comprehensive retirement strategy. To help position your retirement for success, you need to take these RMD changes into account.

How did this all come about?

It’s helpful to know the origins of these RMD changes to understand them fully.

Remember the SECURE Act of 2019? Fun fact: The SECURE Act stands for “The Setting Every Community Up for Retirement Enhancement Act.” It was designed to improve the U.S. retirement system. One of its key provisions changed the beginning RMD age to 72 from 70½, allowing individuals more time to grow their retirement savings.

SECURE 2.0 of 2022 built on these changes by increasing the beginning RMD age again to 73 from 72, with the goal of gradually increasing it to 75 in the future.

The original SECURE Act also created significant changes for beneficiaries of retirement accounts that were inherited in 2020 or after.

Unfortunately, its changes to distribution requirements for inherited accounts caused major confusion for many, so we now have the IRS clarifying these requirements through finalized regulations.

Key developments in the final regulations

The IRS finalized several aspects of RMDs for both account owners and those with inherited accounts. These rules are technical, and we don't expect to be asked for the movie rights any time soon, but you will likely face RMDs in some form, so it will be worth the read.

For original account owners

1. Roth 401(k) holders: The IRS confirmed that starting in 2024, owners of Roth 401(k)s are no longer subject to RMDs during their lifetime.
2. Penalty reduction: The final rules confirm that the penalty for not taking your RMD by the deadline is now reduced to 25% from 50% and can be further reduced to 10% if the mistake is corrected within two years.

For inherited accounts

1. The 10-year rule: The SECURE Act introduced the 10-year rule for accounts inherited in 2020 or after. It required some non-spouse beneficiaries to fully distribute the inherited account within 10 years following the death of the original account owner.
   
   The final IRS regulations explain the details. If the beneficiary inherits the account from someone who has already started taking RMDs, the beneficiary must continue to take RMDs in years one to nine following the original owner’s passing and withdraw the entire balance by the end of year 10.
   
   On the other hand, if the original owner dies before their RMD date, there are no RMDs required in years one to nine. This rule takes effect in 2025.
2. Year-of-death RMD: When the original owner dies, if they haven't taken their RMD yet for that year, the beneficiaries can distribute it amongst themselves any way they choose.
3. Eligible Designated Beneficiaries: Eligible Designated Beneficiaries are defined as surviving spouses, minor children of the account owner, disabled or chronically ill individuals, and beneficiaries not more than 10 years younger than the deceased.
   
   EDBs don’t have to adhere to the 10-year rule. Instead, they can stretch distributions over the course of their life, depending on their life expectancy, or they can choose the 10-year rule if the original account owner died before beginning RMDs.
4. Treatment of trusts as beneficiaries: The IRS also provided additional guidance on how RMDs should be handled when a trust is named as a beneficiary.
   
   Trusts that (1) qualify as see-through trusts and (2) have an EDB, can take stretch RMDs over the EDB’s lifetime.
   
   If the trust is not a see-through trust, then the account has to be fully distributed within five years, but there is no annual RMD requirement.
   
   If the beneficiary of a trust is a noneligible designated beneficiary, then the 10-year RMD rules apply.

Strategic considerations

While the above high-level explanations provide some clarity, in practice, the RMD rules remain complex and can be difficult to navigate. Mistakes can be costly and can adversely impact an optimized tax strategy and overall financial plan.

For example, let’s say you inherit a retirement account worth $500,000. You decide to take only the RMDs each year, and the remainder in the 10th year, and your income in that year is already high. The additional taxable income could push you into the highest tax bracket, resulting in a significant portion of the remaining distribution being lost to taxes.

Alternatively, if you spread the distributions evenly over the 10 years or take distributions in years when other income is low, you might be able to keep your taxable income in a lower bracket, reducing the overall tax burden.

The importance of working with your planner

Your Edelman Financial Engines planner can help you understand how the RMD rules affect your financial plan and help you develop a strategy that aligns with your individual situation and goals. Your planner can also collaborate with your tax professional to help minimize your tax liability and maximize your retirement savings.

If you have any questions about how the new RMD rules may affect your plan, or about your retirement plan in general, contact your planner today. We’re here to help you.

And for more information about required minimum distributions, download our free RMD cheat sheet.