The recent FEDZONE column entitled “Understanding Spousal IRA Beneficiary Rules” reviewed three IRS regulations concerning the naming of a surviving spouse as the beneficiary of the deceased spouse’s traditional IRA. One of the regulations discussed came out of Section 327 of SECURE Act 2.0. On July 18, 2024, the IRS issued proposed regulations on the required minimum distribution (RMD) rules. A significant part of the proposed regulation is the IRS’ interpretation of Section 327.
The Senate Finance Committee Report (explaining the provisions of SECURE Act 2.0) stated the following: “Section 327 allows a surviving spouse to elect to be treated as the deceased employee for purposes of the required minimum distribution rules.”
The question is: What exactly does allowing a surviving spouse to be treated as the deceased spouse for purposes of the minimum required distribution rules mean and what are the implications?
While the statute is not clear, the IRS in releasing the proposed regulations on Section 327 of SECURE Act 2.0, explains the rules with respect to a surviving spouse who is the named beneficiary of a deceased spouse’s traditional IRA. In particular, a spouse died before reaching his or her required beginning date (RBD), which is currently April 1st of the year after the year an individual reaches age 73. Under the IRS proposed regulations, a surviving spouse can delay RMDs until the surviving spouse’s RBD at which time RMDs must start. When a deceased spouse dies before their RBD, then this happens automatically.
The new regulations also make it clear that when Section 327 applies, the traditional IRA is still considered an inherited (death) traditional IRA account. As such, the 10 percent early distribution penalty, applicable for traditional IRA owners younger than age 59.5, does not apply. This is good news for young spousal beneficiaries – those spousal beneficiaries who are in their 30’s, 40’s and 50’s who may need to make withdrawals from inherited traditional IRAs to pay their and other family member expenses In addition, despite the automatic inherited IRA creation, the regulations clarify that a spousal direct rollover of the inherited IRA to the spouse’s own traditional IRA can still be done at any time with no consequences. The following example illustrates:
Example 1. Donald died in April 2024 at the age of 51. Donald’s traditional IRA beneficiary is his wife, Stella, age 53. Stella will not have to take RMDs from her automatically created inherited IRA until Donald would have been required to start taking the RMDs. Donald’s RBD was age 75 and would have occurred in the year 2048, when Donald would have become age 75. When Stella starts taking RMDs, she will use her age when determining the life expectancy factor from the IRS’ Uniform Lifetime Table. In the meantime, Stella can make penalty-free (no 10 percent pre-age 59.5 early withdrawal penalty) withdrawals from the inherited IRA. She will owe income tax on the traditional IRA withdrawals.
Learn more about your retirement benefits at our No-Cost webinars, featuring Ed Zurndorfer -
IRS Proposed Regulations on Spousal IRA Beneficiaries Required to Take RMDs Before Doing a Spousal Rollover
Another IRS proposed regulation resulting from passage of SECURE Act 2.0 applying to a surviving spousal IRA beneficiary requires that in some situations spousal traditional IRA beneficiaries must take RMDs before performing a spousal direct rollover. The IRS calls these RMDs “catch-up” or “hypothetical” RMDs. In making this special rule, the IRS was attempting to close a loophole that spousal beneficiaries could use in limited situations in order to avoid RMDs.
Some background information before presenting the details of the “hypothetical RMDs”. When a surviving spouse inherits a traditional IRA from their deceased spouse, the surviving spouse can remain a beneficiary or perform a tax-free spousal direct rollover to his or her own traditional IRA.
A surviving spouse who chooses to remain a beneficiary of a deceased spouse’s traditional IRA when the deceased spouse died before his or her RBD has options with regard to how to make the required withdrawals from the inherited traditional IRA. In that case, the spousal beneficiary can elect to either stretch RMDs over his or her single life expectancy or use the 10-year payout rule with no annual RMDs. The following example illustrates:
Example 2. Alice inherited a traditional IRA in 2023 (at age 67) from her deceased husband Michael who died at age 71. At the time of Michael’s death, the traditional IRA was worth $175,000. Alice elects to remain a traditional IRA beneficiary. She did not elect to perform a direct rollover into her traditional IRA and elects the 10-year payout rule. Since Michael died at age 71 ( two years before his RBD of age 73), the 10-year payout rule will allow Alice to defer any inherited traditional IRA RMDs until December 31, 2033, which is the end of the 10-year period following Michael’s death.
Alice produces a plan to “game” the system. She will use the 10-year rule with no annual RMDs for 8 to 9 years and then perform a spousal direct rollover to her traditional IRA. In so doing, Alice could avoid annual RMDs that would have required her to take RMDs from her inherited traditional IRA starting at her RBD of age 73.
Unfortunately for Alice, a smart IRA employee already thought of this scenario and came up with the “hypothetical RMD” rule in order to make sure this scenario would not occur. In Alice’s case, this is how the “hypothetical RMD” rule would apply:
Alice is still allowed to perform a spousal direct rollover. However, before performing a spousal direct rollover, she must first calculate the RMD she must take for the year she was age 73. Like any RMDs, these “hypothetical RMDs” are not eligible for direct rollover to her traditional IRA. She therefore must first take those RMDs before she can directly rollover the remaining part of her inherited traditional IRA to her own IRA.
Alice is becoming age 73 in 2029. Suppose that Alice’s inherited traditional IRA balance as December 31,2028 is $240,000. If during 2029 Alice wants to perform a direct rollover of her inherited IRA to her traditional Ira, she must take an inherited IRA RMD equal to:
What Is the IRS’ “Hypothetical RMD Rule” and How Does the Rule Affect Surviving Spouses?
$240,000 (inherited IRA account balance as of 12/31/2028)/26.5 (Uniformed Lifetime expectancy 73-year-old) $240,000/26.5 equals $9,057.
Before Alice can perform a direct rollover of her inherited traditional IRA during 2029, she must first take an RMD of $9,057 in which Alice would have to pay federal and state income taxes for the year 2029. After Alice takes her 2029 inherited IRA RMD, she can directly rollover the balance in the inherited IRA to her traditional IRA.
You Might Also Enjoy This Podcast
Ed Zurndorfer, EA, ATA, CFP®, CLU®, ChFC®, CEBS®, ChFEBC℠: Federal Employee Benefits Expert
A former career Federal employee, Ed has published a staggering 1,200+ separate articles on Federal Benefits and Retirement!
Just “Google” his name, and you are likely to find a plethora of sites that contain his writings. Drawn to its mission to reach, teach
and serve Feds, Serving Those Who Serve is the only financial planning practice with which Ed has chosen to affiliate in over
20 years teaching. In addition to conducting Federal Benefits seminars for Serving Those Who Serve, you can find Ed’s
writings here on our blog in the FedZone, and on Fed-Soup, MyFederalRetirement, FederalNews Radio and NITP.
He is a member of the Maryland Society of Accountants, the National Association of Enrolled Agents, the International Society of Certified Employee Benefits Specialists, the Financial Planning Association, the National Association of Health Underwriters,
and the Society of Financial Service Professionals. Since 1999, Ed has taught many thousands of Federal employees about
their benefits, in person and at Federal agencies all over the country. Ed is a true national treasure.
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street - Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.