RMDs for Beneficiaries in Qualified Retirement Plans

By David J. Kupstas, FSA, EA, MSEA

David J. Kupstas, FSA, EA, MSEA

David J. Kupstas, FSA, EA, MSEA Chief Actuary

When an employee in a qualified retirement plan dies, the employee’s account balance has to be distributed to the beneficiary at a certain rate over a certain timeframe. The money cannot stay in the plan forever. What is that timeframe? When do distributions have to start?

A lot of people are familiar with the rule calling for living employees to begin receiving required minimum distributions (RMDs) at age 70½ (now age 72). The RMD rules also address distributions after an employee has died, whether before or after age 72. This article addresses some of the death RMD rules that apply to qualified defined contribution plans, including 401(k)s and profit sharing plans. Distribution rules governing defined benefit plans and IRAs are not covered here.

Distribution Periods

The maximum period over which distributions may be made to the beneficiary depends on several factors:

  • Whether the employee had attained his required beginning date (RBD) or not. The RBD for most employees is the April 1 following the calendar year in which the employee retires or attains age 72, whichever is later. For more-than-5% owners, it is the April 1 following the calendar year he attains age 72, even if he is not retired. Until 2020, the beginning age was 70½ instead of 72.
  • Whether the beneficiary is an “eligible designated beneficiary,” which means the employee’s surviving spouse or minor child (younger than 21) or someone who is disabled, chronically ill, or no more than 10 years younger than the employee. The concept of “eligible designated beneficiary” was introduced as part of the SECURE Act in late 2019.
  • Whether the sole beneficiary is the employee’s surviving spouse.
  • Whether the beneficiary is a “designated beneficiary” at all. A “designated beneficiary” must be a person. Trusts, estates, and organizations are not designated beneficiaries. While it is true that a trust, estate, or organization may be “designated” by an employee to be his beneficiary, these entities are not “designated beneficiaries” as the term is defined.

The SECURE Act added a rule specifying that, in many cases, the account balance of an employee who died must be distributed in full by the end of the tenth calendar year following the employee’s death. The addition of the 10-year limit under the SECURE Act curtailed what was known as the “stretch IRA,” which allowed beneficiaries to stretch their withdrawals over many years, sometimes well past the expected lifespan of the employee whose money they inherited. The stretch concept applies to qualified plans as well. How to apply the 10-year limit turned out to be controversial and somewhat not intuitive.  More on that later. 

It should be noted that the SECURE Act RMD provisions apply if the employee died after December 31, 2019.  If the employee died before 2020, the old rules apply, meaning stretch payments are grandfathered for those beneficiaries.  The pre-SECURE Act rules are not fully covered here.

Here are the distribution periods that apply after the SECURE Act under various scenarios:

If the employee dies after attaining his RBD:

If an employee dies after attaining his RBD, then there must have been an RMD in the year of death. If the employee took the RMD before he died, nothing further needs to be distributed that year. If the employee did not take the RMD before he died, then the RMD needs to be paid to the beneficiary before the year is up. The RMD amount is the same whether the employee took it before death or not.

After that, it depends on who the beneficiary or beneficiaries is/are:

  1. Distributions to an eligible designated beneficiary may be made over the beneficiary’s remaining life expectancy or the deceased employee’s remaining life expectancy, whichever one is longer. “Remaining life expectancy” is discussed below. It could be different if the spouse is the sole designated beneficiary vs. if not.
  2. For non-eligible designated beneficiaries, the 10-year rule generally applies.
  3. If there is no designated beneficiary, then distributions must be made over the deceased employee’s remaining life expectancy.

If the employee dies before attaining his RBD: 

The employee’s full account balance must generally be paid out by the end of the tenth calendar year following the employee’s death. Exceptions are as follows:

  1. Distributions to an eligible designated beneficiary that is not the employee’s surviving spouse may be made over the beneficiary’s remaining life expectancy. However, if these distributions do not begin in the calendar year following the employee’s death, either by the beneficiary’s election or because of the plan’s terms, then the 10-year rule applies.
  2. If the surviving spouse is the sole designated beneficiary, then the surviving spouse must start taking RMDs when the employee would have attained age 72. The spouse’s RMD amounts are based on the spouse’s remaining life expectancy. If the surviving spouse dies before starting RMDs, distributions shall be made as if the surviving spouse was the employee.
  3. If there is no designated beneficiary, then distributions must be made by the end of the fifth calendar year following the participant’s death. Before the SECURE Act, the five-year rule applied in more instances, but now it applies only when there is no designated beneficiary. Besides the shorter time period, a key difference between the five-year rule and the new 10-year rule is the requirement that life expectancy distributions are required under the 10-year rule but not the five-year rule.

Remaining Life Expectancy 

The “remaining life expectancy” is determined differently depending on whether the surviving spouse is the sole designated beneficiary or not. If the spouse is the sole designated beneficiary, then the remaining life expectancy is the life expectancy based on the spouse’s current age in the year of each distribution.

If the spouse is not the sole designated beneficiary, then the remaining life expectancy is determined using the “subtract one” method, which is the life expectancy as of some initial date minus one year for each calendar year that has elapsed since the life expectancy was first determined. If the life expectancy at age 71 is 16.3 years, then the remaining life expectancy under the subtract one method at age 72 is 15.3 years, at age 73 is 14.3 years, and so on. Compare this to the fresh life expectancies from the life table: 15.5 years for age 72 and 14.8 years at age 73.

In most of the situations we have described, the initial life expectancy for the employee is based on the year of death, while for the designated beneficiary it is for the calendar year following the year of death. This distinction comes into play if the employee and beneficiary are the same age. In that case, the beneficiary’s remaining life expectancy would be used since his life expectancy in the year after the employee’s death will always be greater than the employee’s year-of-death life expectancy minus one.

Other notes on distribution periods are as follows:

  • If the nonspouse beneficiary dies before receiving the deceased employee’s full account balance, payments will continue to a contingent beneficiary for the same distribution period (i.e., with the same life expectancy factors that were being used for the original beneficiary).
  • If there is more than one designated beneficiary, the life expectancy used is based on the oldest beneficiary.
  • Under the five-year rule for deaths before RBD, the account balance may be distributed in chunks over the applicable period or it can be distributed all on the very last day of the fifth year – however the beneficiary wants to do it as long as it’s completely distributed by the deadline.  This is in contrast to distributions under the life expectancy method which must be made each year.  The 10-year rule works differently, as discussed below.
  • Once a minor child reaches the age of majority, he then has 10 years to receive the remaining account balance of the deceased parent/employee, meaning the distribution period for someone who starts getting distributions as a minor child may end up being more than 10 years.
  • If an eligible designated beneficiary dies, the 10-year rule applies to the beneficiary of such eligible designated beneficiary.  That beneficiary doesn't get to use the life expectancy method.
  • Be aware that the distribution period will usually get shorter when an employee dies.  When living, the distribution period is often based on the Uniform Life Table, which is a joint life expectancy that is longer than the life expectancy of a single person.  After the employee's death, distributions are based on the life expectancy of just a single person.
  • An updated mortality table will be used in RMD calculations for 2022 and beyond. In some cases, the remaining life expectancies being used under the subtract one method will be reset.

Confusion on 10-Year Rule

When the SECURE Act was first passed, many believed the 10-year rule worked just like the five-year rule.  Namely, if desired, no distributions had to be taken until the very end of the tenth year.  Proposed regulations issued in February 2022 indicated that, no, distributions under the life expectancy method had to be taken for each year one through nine, then the remainder of the account had to be distributed by the end of year 10.  This caused much consternation among those who did not take the requisite distribution in 2021 and had not planned on doing so for 2022.  (RMDs weren't required in 2020.)  So, in Notice 2022-53, the IRS clarified that under the 10-year rule you do indeed need to take distributions under the life expectancy method up until year 10, at which time the rest of the account needs to be paid out, but they were going to be nice and not ding you with the applicable penalty taxes for 2021 or 2022.  Going forward, you needed to take the life expectancy distributions.  One may infer, although it's not stated, that the "missed" distributions for 2021 and 2022 do not have to be taken retroactively.

Rolling Over

Let’s switch gears and talk tax. A beneficiary receiving RMDs must pay taxes on the distributions in the year the money was received. The annual distributions under the life expectancy method are subject to income tax, as would a big lump sum distribution paid within five years or 10 years of the employee’s death.

A beneficiary might think, “Ah, let me roll the account balance over to an IRA so I can avoid paying income taxes until a time far off in the future.” Unfortunately, that’s not going to work. Even if the money is rolled into an IRA for a nonspouse beneficiary, it still must be distributed under the rules governing the plan from which the rollover came. There is no tax-deferral advantage for a nonspouse beneficiary to roll over to an IRA, although there may be other reasons to move the account from the qualified plan to an IRA. For what it’s worth, the IRAs in these cases are to be treated as inherited IRAs and should be titled thusly.

The rules are different when the sole beneficiary is the spouse. A surviving spouse may be able to postpone RMDs until the employee would have attained age 72 by rolling to an inherited IRA. Likewise, a surviving spouse may be able to roll over the deceased employee’s account to the spouse’s own IRA and avoid taking RMDs until the spouse’s own age 72.

Prior to 2007, a nonspouse beneficiary was not able to do a direct rollover of a qualified plan account balance.

Missing the Required Beginning Date

It is easy to miss RMDs when an employee dies prior to attainment of age 70½ or 72. Plan sponsors may simply not be aware that distributions must be made relatively soon if the beneficiary is not the spouse. They might think the beneficiary can wait until he turns 72 or until when the employee would have turned 72. Or, they may be well aware of the rules but never be notified that a terminated employee has died. Plan sponsors often lose track of employees who have not worked at the company in a number of years. We had one instance where there was a change in personnel and a change in recordkeepers, a beneficiary was inadvertently coded as a terminated employee, and no one knew RMDs were owed until quite a while after the actual employee’s death.

Suppose an employee with a nonspouse beneficiary died 10 years ago, and no RMDs were ever made on his behalf. Either partial distributions should have started in the year after death, or the whole account balance had to be distributed within five years (under the pre-SECURE Act rules). Since neither of these happened, there is a big problem. A missed RMD is subject to a 50% excise tax payable by the beneficiary.

In lieu of paying the tax, the beneficiary can write a letter to the IRS asking for mercy and for the tax to be waived. The letter might actually work if there is a good reason the RMD was missed. Alternatively, the plan may file under the IRS’ Voluntary Correction Program and potentially get the taxes waived. There are fees for utilizing this program, though.

Once the error is discovered, a makeup distribution has to be made. This would be the sum of all the missed distributions plus earnings. An interesting question is, can the makeup payment and subsequent distributions be based on the life expectancy rule if the beneficiary originally had that option, or must the entire account balance be distributed because the beneficiary missed his chance at the life expectancy rule by not taking a distribution in the year after the employee’s death? The IRS issued a Private Letter Ruling (200811028) indicating the life expectancy method is still available under these circumstances. A PLR is valid only for the taxpayer who requested it, but PLRs do give some indication that the same approach taken by someone else might be considered reasonable.

Note:  This article was updated on November 21, 2022 to reflect certain components of the proposed Section 401(a)(9) regulations issued in February 2022, specifically that 21 is the age at which a child is no longer a minor and that life expectancy distributions have to be taken under the 10-year rule rather than a beneficiary's being able to wait until the end of the tenth year to receive the account in full.  Other aspects of the proposed regulations are not addressed here, but we believe nothing written here conflicts with those proposed regulations.  

The content of this article is for general informational purposes only and may not be construed as tax advice. Readers weighing options with respect to retirement plan distributions will wish to contact their own advisors qualified in tax planning.

— Topics: 401(k), Retirement, RMD, 70 1/2, death, required minimum distribution, beneficiary, secure act, nonspouse