The SECURE 2.0 Act of 2022, enacted Dec. 29, includes almost 100 new retirement plan provisions, many of which aren’t effective yet. But some big changes involving required minimum distributions and related penalty relief are already in effect, and financial and tax advisors should be communicating these changes to clients now.
SECURE 2.0 raises the age for required minimum distributions from 72 to 73 in 2023, and then to 75 a decade later, in 2033.
As happened before, when the original SECURE Act increased the age from 70½ to 72, this transition to 73 will create some confusion for clients. The easiest way to explain it to them is to use this simple guide based on the year they were born:
Those who have already begun RMDs must continue on the same schedule.
Up to now, one of the largest penalties in the Tax Code was the 50% penalty for not taking an RMD. It was based on the RMD amount that should have been taken but wasn’t.
SECURE 2.0 lowers this penalty to 25%, and then to 10% if the missed RMD is timely made up. According to the new law, “timely” means by the end of the second year after the missed RMD, or earlier if IRS has assessed the penalty.
For example, if Joe didn’t take his RMD in 2022, he has until the end of 2024 to make up the missed amount. But unlike in the past, where merely making up the missed RMD almost certainly avoided the 50% penalty, now this could result in a 10% penalty.
The IRS has been very liberal in waiving the 50% penalty if the RMD was made up and a reasonable explanation was provided, for example, confusion over the RMD rules, medical issues, a death in the family or incorrect advice.
But now that the penalty is only 10%, it may be assessed more often. Although the law is silent on the issue, making up a missed RMD and providing a reasonable explanation for it on IRS Form 5329 may still allow the IRS to waive the penalty. As of now, it’s unknown whether the IRS will be as generous with penalty waivers as in the past when the penalty was 50%.
With that in mind, remind your clients to be more diligent about taking their RMDs, since they may be more likely now to get dinged with the new 10% RMD penalty.
This includes beneficiaries, too. In fact, beneficiaries are probably even more susceptible to the penalty. That’s because the beneficiary RMD rules have become much more complicated, with the 10-year payout rule, the need for certain beneficiaries to take RMDs for years one through nine of the 10-year term and the fact that certain beneficiaries still qualify for the stretch IRA. On top of all that is the increased calculation confusion from these recent RMD rule changes.
IRS Form 5329 is the tax form used to report retirement plan penalties and to request a waiver of the RMD penalty. In the past, not filing Form 5329 for penalty relief meant that the general three-year statute of limitations that applies to most other tax return issues wouldn’t begin. Individual retirement account penalties for missed RMDs (now 25%/10%), early distributions (10%) and excess IRA contributions (6%) could be assessed years later, plus interest, nonfiling and nonpayment penalties.
SECURE 2.0 corrects that problem by adding a statute of limitations based on when the individual federal income tax return, Form 1040, was filed, even if Form 5329 weren’t filed. (In cases where no federal income tax return is required to be filed, the statute period would begin on what would have been the tax filing deadline.) The new statute of limitations applies to missed RMDs (3 years) and excess IRA contributions (6 years), but not to early distributions.
Even so, this is an important and welcome change. Up to now, Form 5329 was considered a separate tax return (since it had its own signature line). If it wasn’t filed, the statute could stay open for years, allowing (possibly unknown) penalties and interest to keep accruing.
Congress realized that in many cases, those with retirement accounts weren’t even aware of the filing requirement for Form 5329 if they missed an RMD or made an excess contribution. This led to an indefinite, open-ended period in which penalties and interest could accumulate.
This issue came to light back in 2011, when the IRS was successful in winning several tax court cases and recovering huge penalties and interest that had mounted for years. These big cases (the landmark Paschall and Swanson cases) involved highly complex tax schemes to contribute millions of untaxed funds to Roth IRAs. The IRS was able to assess years of penalties in these cases since the return was never filed to report the 6% excess IRA contributions penalty and so the Form 5329 statute of limitations never began. The court allowed the IRS to go back many years to collect the penalties and interest.
Most clients aren’t doing these tax schemes, but the change is good news to protect people from unintentional oversights on these penalty issues. After all, if a client didn’t know they made a mistake, how would they (or their tax preparer) even know to file Form 5329? This would leave them indefinitely exposed.
The above Roth IRA abuse cases may be why the SECURE 2.0 Act makes the statute of limitations 6 years for the 6% excess IRA contribution penalty. Even then, if an IRA has acquired property for less than its fair market value, this statute of limitations relief is unavailable, and the statute would remain indefinite if Form 5329 isn’t filed.
In addition to the RMD penalty relief, SECURE 2.0 expands the IRS self-correction program, called the Employee Plans Compliance Resolution System, or EPCRS, to include inadvertent individual retirement account errors, including a waiver for failure to take RMDs. However, EPCRS self-correction for IRAs may not be available for two years, since SECURE 2.0 gives the IRS that amount of time to provide guidance on this.
SECURE 2.0 also finally eliminated required minimum distributions for Roth 401(k)s and other employer Roth plans. Roth IRAs were never subject to lifetime RMDs, but Roth 401(k)s were. As a result, some employees who wanted to keep their Roth 401(k) funds in their company plan, for ERISA creditor protection, investment options or other reasons, were advised to roll those funds over to their Roth IRA to avoid the RMDs in the company plan. Starting in 2024, that will be unnecessary since Roth 401(k) funds will be exempt from RMDs.
For more information on Ed Slott and Ed Slott’s 2-Day IRA Workshop, please visit www.IRAhelp.com.
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