NAFCU Services Blog

By Jonathan Yahn | JD, CPC | Ascensus

The IRS has always treated IRA (and qualified plan) spouse beneficiaries quite generously. But the new RMD rules may make executing certain options more complicated. These two spouse beneficiary changes have drawn the most attention: a new deadline for spouse beneficiaries to treat inherited IRA assets as their own, and a new “hypothetical RMD” that may apply to certain spouse beneficiaries.

Deadline for Spouse Beneficiaries Treating the IRA as Their Own

Existing Regulations – Under the current rules, the surviving spouse of an IRA owner has the option to “treat as own” at any time and at any age, as long as the surviving spouse is the sole beneficiary or, if there are multiple beneficiaries, separate accounting has been applied timely. The existing regulations also define “treat as own” narrowly. Spouse beneficiaries are deemed to treat an IRA as their own if they:

• transfer the IRA assets to their own IRA,
• make a contribution to the inherited IRA, or
• fail to withdraw a required distribution from the inherited IRA.

If separate accounting is not in place by December 31 of the year following the year of death, then the spouse beneficiary could still take a distribution and, if eligible, roll over the assets to her own IRA. So even though the mechanism is different, the result is the same: the original IRA owner’s assets are now in the spouse beneficiary’s own IRA. Most spouse beneficiaries transfer the decedent’s IRA assets into their own IRA. This is a cleaner way to move the assets; there is no reporting by either the financial organization (on IRS Forms 1099-R and 5498) or by the spouse (on an IRS Form 1040).

Some spouse beneficiaries may benefit from keeping the assets in an inherited IRA—at least temporarily—rather than treating as their own. For example, a spouse beneficiary under age 59½ may want the option of being able to take death distributions, which are exempt from the 10 percent early distribution penalty tax. Once the spouse attains age 59½, this additional tax no longer applies, so the spouse may decide to transfer the assets into the spouse’s own IRA at that time.

Proposed Regulations – Under the proposed regulations, spouse beneficiaries would be able to treat an inherited IRA as their own in the same manner as under the existing regulations—but they would have to do it by a specific deadline. The proposed deadline for this election is the later of:

• the year following the account owner’s death, or
• the year in which the spouse beneficiary reaches age 72.

After these dates, spouse beneficiaries could not treat an IRA as their own—such as through a transfer—but could distribute and roll over the inherited assets to an IRA, if otherwise eligible.

Example: Patty, age 62, died on March 18, 2022. Her spouse, Gregg, age 72, is the sole beneficiary of her IRA. Gregg can either transfer the assets to his own IRA or leave them in an inherited IRA. If Gregg decides to transfer the assets to his own IRA, the proposed regulations would require him to do this by December 31, 2023, the year after the year in which Patty died. (Gregg had already turned 72.) After that date, Gregg could still take a distribution and roll over the assets to his own IRA if eligible. If Gregg leaves the assets in an inherited IRA, he would not have to start taking single life expectancy payments until the year Patty would have turned 72, some 10 years after her death.

"Hypothetical RMDs"

Under the proposed regulations, surviving spouse beneficiaries who initially chose to distribute assets under the 5-year rule or the 10-year rule may need to take a hypothetical RMD if they later decide to roll over the inherited assets to their own IRA. The hypothetical RMD equals an amount that would have been required to be distributed had the life expectancy rule applied to the spouse beneficiary. This amount must be excluded from any rollover contribution, apparently to remove any temptation to avoid RMDs that normally would apply to the surviving spouse beneficiary.

Spouse beneficiaries may be required to take hypothetical RMDs if:

• the account owner died before the required beginning date (RBD),
• the spouse beneficiary had elected the 5-year or 10-year rule, and
• the spouse beneficiary rolls over inherited assets to his own IRA before the last year in the period and in a year that the spouse attains age 72 or older.

Example: Martha, age 66, died on May 18, 2022, leaving her IRA to her husband, Mark, age 64. At first, Mark decides to keep the assets in an inherited IRA and distribute them under the 10-year rule. Mark does not take a distribution until 2031—the ninth year after Martha’s death—at which time Mark decides to roll over the assets to his own IRA. Because Mark is 73, he has to calculate two hypothetical RMDs, based on his single life expectancy in the years that he would have had to take payments. These hypothetical RMDs are ineligible to be rolled over, so Mark distributes the hypothetical RMDs before rolling over the remaining balance to his own IRA.

No Transition Guidance Yet

Although the proposed regulations have not yet been made final, they are currently proposed to be retroactively effective as of January 1, 2022. The IRS held a public hearing on the new rules on June 15, 2022, and is currently reviewing comments received on the proposed guidance. As a result, it may take several months for the IRS to release final regulations.  

This may be a good time to review the proposed regulations before they become permanent. If your members are unsure which option is best for them, they should consider seeking competent tax advice before making a decision.