The Problem
With 76 million baby boomers in the throes of taking RMDs, the volume of RMD calculations is set to skyrocket. Financial professionals face multifaceted scenarios that often span two or three generations of inheritors. Notably, RMD calculations are not one-and-done. Rather, calculations are required every year. Further, the calculations for beneficiaries persist for at least ten years after the participant dies.
To avoid the risk of inaccurate or insufficient RMD withdrawals, streamlining RMD calculations is crucial for every investment management firm. Compliance departments are very focused on investment-related compliance with FINRA and SEC rules, but less so on compliance with IRS rules governing RMDs.
RMDs are only a small part of an investment advisor’s workload, yet the calculations demand intricate attention to detail. Consequently, firms generally assign one person as the RMD guru for all the firm’s advisors. The RMD guru is also responsible for tracking withdrawals to ensure clients take their RMDs before the end of the year.
Understanding the Calculation Levels
To comprehend the RMD calculation quagmire, think of a three-generation family in terms of RMD calculation levels:
First level – Parent (participant alive, the account owner)
Second level – Spouse or Child (original beneficiary)
Third level – Grandchild (successor beneficiary).
The first-level calculation considers whether the participant is alive or deceased. When alive, the participant has to start taking RMDs when they reach one of the four required beginning dates, which depend on the participant’s date of birth. The calculation for a living participant is straightforward. Please refer to the participant’s longevity factor in the IRS uniform life table and divide it by last year’s ending market value. That’s the RMD. Every calculator on the Internet can handle this simple calculation, but many websites do not dare to go beyond the first level.
The second level addresses RMDs for the inheritor of a deceased participant. The original beneficiary (surviving spouse or designated beneficiary) must take an RMD in the year after the participant’s death, except in certain circumstances. The amount of the RMD depends on the deceased participant’s date of birth and date of death, as well as whether the participant had reached their required beginning date.
The second-level calculations also have to factor in the inheritor’s date of birth. Many second-level calculations use the IRS single-life table, which is less beneficial than the uniform life table.
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The secret to ensuring accuracy and auditability is to avoid using spreadsheets, which often fail to account for the decision forks required in some calculations.
After 2019, there are beneficial carveouts for inheriting spouses, disabled or chronically ill beneficiaries, minors and beneficiaries who are not more than 10 years younger. All of these inheritors are considered Eligible Designated Beneficiaries (EDBs) and are subject to special rules with varying complexity.
Second-level inheritors who do not meet the EDB criteria are generally subject to the 10-year payout rules. Some original beneficiaries who inherited before 2020 can still invoke the old “stretch IRA” rules.
The third level provides rules for successor beneficiaries who inherit the account from the original beneficiary. The 10-year rule introduced by the SECURE Act generally applies. However, if the original beneficiary had a life expectancy of less than 10 years, the successor beneficiary must step into the original beneficiary’s shoes for the remainder of the original beneficiary’s life expectancy.
New RMD Rule for Older Surviving Spouses
Section 327 is a new section of the tax code, effective in 2024, that permits an older surviving spouse to use the more favorable uniform life table, which includes a built-in 10-year (younger) offset. Spreadsheets may not trigger this advantageous option.
Avoid RMD spreadsheet calculations.
The secret to ensuring accuracy and auditability is to avoid using spreadsheets, which often fail to account for the decision forks required in some calculations. For example, the 10-year rule often applies to successor beneficiary calculations, but the ‘earlier of’ rule overrides it and requires earlier final distributions. This situation occurs when the original beneficiary is elderly with a longevity factor of less than 10 years. Mistakenly applying a 10-year distribution period exposes the firm to a 25 percent under-withdrawal penalty each year while the insufficient withdrawals occur.
A pre-programmed tool that incorporates all the decision trees in the RMD rules ensures accurate and reliable calculations. Input pages should merely require the dates of birth and death for the people in the scenario, along with their familial relationships (to identify spouses). The RMD database program can do the rest.
