April 2022

IRS Proposes Major RMD Changes for Spouse Beneficiary

After the death of the IRA owner under existing rules, a surviving spouse who is the sole primary beneficiary has the right to elect to treat the deceased spouse’s IRA as his or her own IRA. This is a very valuable tax planning tool for certain marriage/death situations. Generally, a surviving spouse will want to elect to treat their deceased spouse’s IRA as their own IRA. And then if the surviving spouse is age 72 or older the standard RMD rules will apply to the surviving spouse. But there are situations where a spouse beneficiary does not want to elect to treat their deceased spouse’s IRA as their own The survivor wants to keep it as an inherited IRA. See the two examples discussed later.

From 2002-2021 the right of spouse to elect to treat as own was unlimited. The election could be made at any time. That is, even if a spouse decided initially to maintain the inherited IRA as an inherited IRA he or she had the right to later elect to treat the deceased spouse’s IRA as their own IRA.

The IRS has proposed that there will be a deadline for a surviving spouse to make the election. The election must be made by the later of-
1. December 31 of the calendar year in which the surviving spouse reaches age 72 or
2. December 31 of the calendar year following the year the deceased IRA owner died.

A surviving spouse loses the right to treat the deceased spouse’s IRA as their own if the election is not made by the deadline. The surviving spouse must then use the life distribution rule or the 10-year rule as applicable.

Why is the IRS wanting to make this change? The IRS believes without these limits a spouse has tax planning options which favor some spouses too much.

How may a surviving spouse benefit too much by electing to treat their deceased spouse’s IRA as their own IRA?

The first two examples deal with the IRA owner being younger than their spouse and the IRA owner dies before their required beginning date.

Example#1. An IRA owner dies in 2014 at age 69. His spouse beneficiary was older than he was. She was age 74. The IRA owner had died before his required beginning date. She had the right to use either the life distribution rule or she could elect to use the 5-year rule because he had died before his required beginning date. Under the 5-year rule she was required to close this inherited IRA by 12/31/2019. If she elected to use the 5-year rule she was not required to take any RMD for years 2015-2018. And with respect to 2019 she had until 12/30/2019 to elect to treat the inherited IRA as her own IRA. Her election would require her 2019 RMD to be recalculated using the balance of that inherited IRA as of 12/31/2018, but she has definitely benefited by electing to use the 5-year rule. The IRS thinks she should not be able to benefit in this way.

Example#2. This example is similar to Example #1 except the IRA owner died in 2021 at age 70. His spouse beneficiary was older than he was. She was age 75. The IRA owner had died before his required beginning date. She had the right to use either the life distribution rule or she could elect to use the 10-year rule. Under the 10-year rule she is required to close this inherited IRA by 12/31/2031. If she elected to use the 10-year rule she is not required to take any RMD for years 2022-2030. And with respect to 2031 she has until 12/31/2031 to elect to treat the inherited IRA as her own IRA. Her election would require her 2031 RMD to be recalculated using the balance of that inherited IRA as of 12/31/2030, but she definitely will benefit by electing to use the 10-year rule. The IRS thinks she should not be able to benefit in this way.

Example #3. An IRA owner died in 2014 at age 82. His spouse beneficiary was age 86. She did not elect to treat his IRA as her own in 2014. Rather she kept it as an inherited IRA. Because she had elected the 5-year rule, this inherited IRA had to be closed by December 31, 2019. Under the existing rules she could elect to treat his IRA as her own in 2019. This meant her 2019 RMD had to be recalculated and was larger, but she did have to withdraw any amount for years 2015-2018. She might have died during this period.

The IRS is now proposing to place a new limit on the right of a spouse to elect to treat their deceased spouse’s IRA as his or her own. It is Example #2 and Example #3 which the IRS wants to limit. Under the SECURE Act the 5-year time period has been replaced with the 10-year rule and the benefits to the spouse (and to her beneficiaries) can be very good.

Note a surviving spouse loses the right to treat the deceased spouse’s IRA as their own if the election is not made by the deadline.

If the old rules are allowed to be continued many IRA owners/IRA beneficiaries would elect to use the 10-year rule because no distributions are required for years 1-9 and then the electing as own means their 2301 RMD will be larger but it need not be a lump sum distribution.

Example #3A. An IRA owner died in 2021 at age 82. His spouse beneficiary was age 86. She did not elect to treat his IRA as her own in 2021. Rather she kept it as an inherited IRA. If she is able to use the 10-year rule then she is not required to take any RMD for years 2022-2030. This would mean her 2031 RMD would be much larger, but still a lump sum distribution would not be required.

So a spouse will no longer be able to use the 10-year rule and then at the end of this period elect as own. They would be required to take the lump sum distribution in the 10th year.

What is the IRS not proposing to change regarding RMDs for IRAs?

The prior election procedures have not changed. First, the spouse beneficiary must inform the IRA custodian/trustee that he/she is redesignating the account from being an inherited account to being their own personal IRA. We at CWF have designed our forms so the spouse checks a box instructing the IRA custodian/trustee that he or she is make the election to treat as their deceased spouse’s IRA. Second, a spouse’s failure to withdraw an RMD automatically results in an automatic election as does the spouse making an annual contribution.

Special Rule for Certain Distributions to Surviving Spouses
This special rule limits the ability to initially use the 5-year rule or the 10-year rule and then later commence annual distributions because the spouse either elects as own or makes a rollover contribution.

The concept is - although the spouse is not required to take any distribution in years 1-4 or years 1-9, a portion of their account balance each year will be deemed to be an RMD and ineligible to be treated as own or rolled over.

This rule applies if the spouse takes a distribution from their inherited IRA in or after the year the spouse attains age 72. A portion of this distribution will be a deemed RMD and is ineligible to be rolled over.

The annual deemed RMD is the sum of each years hypothetical RMD as reduced by any actual distributions. The RMD is calculated by using the life expectancy rule. The first year is the later of the year the spouse reaches age 72 or the calendar year in which IRA owner died. The last year is the year the distribution occurs. The RMD is calculated by using the life expectancy rule, but it is modified. The balance as of the preceding 12/31 must be modified each year. It is reduced by the sum of the hypothetical RMDs for the prior years over any actual distributions during those prior years.

If a spouse misses the deadline for electing to treat as his or her own, the spouse still has the right to rollover to his or her own IRA, but the spouse would be subject to the rule that a portion of the distribution would be an RMD ineligible to be rolled over.

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