401(K): NEW IRS PROPOSED REGS UPDATE RMD RULES FOR SECURE ACT AND OTHER CHANGES

On February 23, 2022, the IRS released new proposed regulations on required minimum distributions (“RMDs”) under tax-qualified retirement plans, including 401(k) plans. Among other things, the new proposed regulations incorporate changes made by the Setting Every Community Up for Retirement Enhancement (“SECURE”) Act, including changing the age linked to the “required beginning date” from age 70 ½ to age 72. Read our blog for a general overview of the SECURE Act.

Recently, a new IRS mortality table that became effective on and after January 1, 2022 lowered the amount of RMDs under 401(k) retirement plans for many participants who are required to receive such distributions in 2022 and beyond.

DISCLAIMER: The new proposed regulations are lengthy and highly technical in places. This article is intended as general information on the most prominent features of the new proposed regulations concerning RMDs for 401(k) plans. It is not meant to address the details of RMDs, 401(k) plan distributions generally, RMDs under other retirement plans (such as defined benefit plans) or individual retirement accounts (“IRAs”), or previous or related IRS or other official guidance on this topic. As always, be sure to consult with your own ERISA attorney or other professional advisor for individualized advice with respect to your 401(k) plan’s unique situation.

Background. Tax-qualified retirement plans, including 401(k) plans, must provide that participants who attain age 72, and who are not still actively employed, must begin to receive a portion of their plan account balances by no later than their “required beginning date.”

• For participants not still working, the “required beginning date” is usually the first day of the month after the participant becomes age 72 years old (as previously stated, prior to the SECURE Act, this was age 70 1/2).
• The first RMD must be paid out by no later than the April 1st following the end of the calendar year in which the participant attained age 72.
• Generally stated, the amount required to be distributed each year is calculated as a percentage of the account balance as of December 31 of the previous year, beginning with the year prior to the year in which the participant attains age 72.
• The required percentage increases with age, reflecting the participant’s reduced life expectancy, using a formula based on an IRS table.
• This table estimates the maximum number of years (also known as “distribution periods”) a participant’s account may need to make RMDs to the participant and, if applicable, his or her surviving spouse.
• As a general rule, longer life expectancies result in longer distribution periods, which translates to less money distributed per period.

RATIONALE BEHIND RMDs: The purpose of the RMD rules is to ensure that people actually use the lion’s share of their retirement plan money during their lifetimes, as opposed to letting 401(k) and similar plans become, essentially, estate planning vehicles. Furthermore, since contributions (other than Roth 401(k) contributions and other after-tax contributions) are made with pre-tax dollars — and interest on 401(k) contributions accumulates tax-free over the course of many years — the Federal government has a vested interest in collecting as much tax revenue as possible, since the tax code has effectively bargained away a large amount of otherwise potential tax proceeds in exchange for the policy goal of providing retirement incentives.

Key SECURE Act Changes.

• The SECURE Act revised the starting date for RMDs, generally now defined as the April 1 of the calendar year following the later of (i) the calendar year in which the employee either turns age 72; or (ii) retires.
• This change was effective for distributions required to be made after Dec. 31, 2019, with respect to individuals who attained age 70 ½ after such date.

Elimination of “Stretch” Distributions.

• The SECURE Act also effectively eliminated so-called “stretch” 401(k) plan distributions, by requiring distributions to non-spouse beneficiaries (other than” eligible designated beneficiaries”) to be completed within 10 years following a plan participant’s death.
• Prior to the SECURE Act change, these distributions could usually be made over the beneficiary’s life or life expectancy.

Highlights of the New Proposed Regulations. The following are highlights of the major provisions and clarifications included in the new proposed regulations applicable to 401(k) plans:

• To clarify an ambiguity in the statutory language, the new proposed regulations endorse a simple “birthdate rule.” Generally stated, if a participant’s birthdate is on or after July 1, 1949, his or her age is deemed to be 72 for purposes of RMDs. (This prevents participants from having to “survive into” the designated age.)
• Implementing the SECURE Act change which mandates the “ten-year rule” in most situations (see “Elimination of ‘Stretch’ Distributions,” above), the new proposed regulations generally require full distribution of a deceased participant’s entire benefit by the earliest of:
  • The end of the tenth year following the participant’s death, if the beneficiary is not an “eligible designated beneficiary”;
  • The end of the tenth year following the year of an “eligible designated beneficiary’s” death;
  • The end of the tenth year following the year of a child “eligible designated beneficiary’s” attainment of majority (see below); or
  • The end of the year in which the “eligible designated beneficiary’s” life expectancy would be equal to or less than that of the participant.

• For purposes of determining whether a child constitutes an “eligible designated beneficiary”, children are treated as having reached the age of majority upon their 21st (not 18^th) birthday.
• The new proposed regulations define the terms “disability” and “chronically ill,” and provide documentation and timing requirements for purposes of determinations as to whether disabled/chronically ill participants qualify as” eligible designated beneficiaries.” Use of the Social Security Act definition of “disabled” now constitutes a “safe harbor” standard.

• The new proposed regulations change the general rule for determining life expectancy when there are multiple beneficiaries. Instead of using the shortest life expectancy, the determination is now made on the basis of the life expectancy of the oldest designated beneficiary.
• As previously noted, there are many other provisions that are either highly technical or relatively minor that are beyond the scope of this general overview.

Applicability Dates. The new proposed regulations are scheduled to be effective for purposes of determining RMDs and death benefit distributions for calendar years after January 1, 2022.

For the 2021 distribution calendar year, taxpayers must apply the present-day final regulations, but are required to take into account a reasonable, good faith interpretation of the amendments made by the appropriate sections of the SECURE Act. For this purpose, compliance with the new proposed regulations is deemed to satisfy that requirement.

Comments and Public Hearing. The IRS is soliciting public comments on the new proposed regulations prior to a public hearing scheduled for June 15, 2022, at 10:00 am. Comments from interested parties are strongly encouraged to be submitted electronically via the Federal eRulemaking Portal at www.regulations.gov (indicate “IRS and REG-105954-20”), by following the online instructions for submitting comments. In order to be taken into consideration, all comments must be received by May 25, 2022.

The information and content contained in this blog post are for general informational purposes only, and does not, and is not intended to, constitute legal advice. As always, for specific questions concerning your 401(k) retirement plan, or for help in operating your plan during the current COVID-19 crisis, please consult your own ERISA attorney or professional advisor.