IRS "Hypothetical RMD Rule" Prevents Surviving Spouses From Avoiding RMDs
Preventing Spouse Beneficiaries From Avoiding RMDs
One of the more interesting rules (if any could be called “interesting”) from the 2022 IRS proposed regulations requires spouse beneficiaries in some situations to take RMDs (required minimum distributions) before doing a spousal rollover. The IRS calls these RMDs “catch-up” or “hypothetical” RMDs. At first, it was hard to figure out where the IRS was going with this special rule. But after some analysis, it is clear the IRS was trying to close a loophole that spouse beneficiaries could use in very limited situations to avoid RMDs.
IRS "Hypothetical RMD Rule" Prevents Surviving Spouses From Avoiding RMDs
Here’s some background. When a surviving spouse inherits an IRA, that spouse can remain a beneficiary or do a spousal rollover (a rollover to her own IRA). There’s another IRS rule that applies when a surviving spouse who remains a beneficiary inherits from an IRA owner who dies before his RMD “required beginning date” (April 1 of the year following the age 73 year). In that case, the spouse beneficiary can elect to stretch RMDs over her single life expectancy or use the 10-year payout rule with no annual RMDs. (This election is available to other “eligible designated beneficiaries” as well).
Scenario Example: Ava and Manuel
So, let’s assume we have surviving spouse Ava who inherits an IRA at age 70 in 2023 from her deceased husband Manuel who died at age 72. Ava decides to remain a beneficiary and elects the 10-year rule. Since Manuel died before his RMD required beginning date, the 10-year rule would normally allow Ava to defer any RMDs until 12/31/33 – the end of the 10-year period.
Ava thinks she can game the system. She could use the 10-year rule (with no annual RMDs) for 8 or 9 years and then do a spousal rollover. That way, she could avoid annual RMDs that she otherwise would have been required to take from her own IRA starting at age 73.
Hypothetical RMD Rule: Closing the Loophole
Unfortunately for Ava, some smart IRS employee already thought of this and came up with the hypothetical RMD rule to stymie this scheme. Ava can still do a spousal rollover. But she must first calculate the RMDs she would have taken for each year she was age 73 or older. Like any RMDs, these hypothetical RMDs are not eligible for rollover. So, she must first take those RMDs before she could roll over the remaining part of the inherited IRA in a spousal rollover to her own IRA.
Add this to the list of “too-good-to-be-true” tax avoidance ideas foiled by the IRS.
By Ian Berger, JD
IRA Analyst
Ed Slott and Company, LLC
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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.