Transcript:
Easan Arulanantham:
Should I be doing anything differently with my strategy for withdrawing from my beneficiary IRA? Would the proposed rules caused me to have any kind of penalties for missing these withdrawals in the past?
Tom Vaughan:
This is a question that actually comes up within our client strategy sessions. And it’s a really, really amazingly complicated, requiring them to Required Minimum Distributions, we call them RMDs. Been around for a long time, they’ve always been complicated, there’s been many different changes to them also. So let’s try to discuss what the question is, number one, somebody inherits an IRA. Right. So they call it a beneficiary IRA, there are a lot of different things that can happen, depending on who you are, and who the person was that gave it to you. So if you’re a spouse, and so your spouse passes away, and that spouse has an IRA, you can make that your IRA, right? So that’s fairly straightforward, and that we get a lot of those, those are pretty simple. And then, then it’s just yours. And you’ve handled that, like you normally would, when you get to be 72, you have to start taking money out. And, you know, there’s that’s the normal process. But a beneficiary IRA is established if it’s not a spouse, so it’s a separate account is kind of set up, money goes in there. So could be from your parents could be from a sibling, a friend, whoever it is. And then there is criteria for how you take the money out, and it gets super crazy. So first of all, a normal I’ll call it a normal, if there is such a thing, a normal beneficiary IRA is one where you have to distribute the money over a 10 year period. So this is somewhat new, it’s only been around for what if three or four years? Yeah, when they’re active, secure act. Yeah. So 2020? Yeah, 2020 was? Yeah, so they snuck this in there they moved. I think it’s, I think it’s bad, they moved the minimum distribution age back from 70 and a half, which to 72, which sounds great, except they made it so that you have to the beneficiaries, a normal beneficiary has to take the money out over a 10 year period, before they could stretch that what we used to call a stretch IRA, we can stretch that out for the lifetime of the beneficiary. And so those are really awesome, that take a little bit each year, and no real big problems as far as that goes. So now, if you have to take all the money out in 10 years, there’s a couple of issues that I see.
Number one is just the size, the size of the IRA, that you inherit matters. If you inherited a $20,000 IRA, and you have to take it out over 10 years, the strategies aren’t that critical. It’s not enough money to really push you into higher tax brackets, or those types of things. If you inherited a two $2 million IRA, that’s a totally different deal. Because now you’re talking about a lot of money. And, and basically, generically, what I would do without knowing anything else, is basically just take out, you know, I call it a 10 year Required Minimum Distribution, divided by 10. The first year, take that out, divide by nine, use the ending year value next year divided by nine, take that out, divide by 87654. And so if I didn’t know anything else, that that’s one of the strategies I would use just because what I don’t want to have happen, is all of that money, a $2 million IRA, that’s now turned into $3 million, over 10 years, because that 7% Money doubles every 10 years. Right? So that’s right, double. So before a million dollars, that’s a huge amount of money to have come out at the end. Right?
There are all kinds of other issues there. Maybe you’re about to retire, we were talking about this earlier, you know, so two years from now, you’re going to retire. So maybe you don’t want to take the distribution now, because your incomes already pretty high. And you’re going to have a lower income, you know, in right after retirement. And so maybe you divide by X after retirement. And you know, so you got to look at okay, oh, we’re going to, you know, have this big income event at this point in time. Maybe we don’t take it then. Right, and all these things. So there, there are some pieces and then depending on the rate of return that you could expect, you can run some scenarios to see well, would it make sense to wait and take it all at the end, even if it was a huge tax gain, because it’s still allowed to grow tax deferred versus pulling it out now I gotta pay the tax I got less money. And now it’s growing but it’s less money and it’s growing, you know, at a taxable rate, basically, capital gains rate, which isn’t terrible, but and so there is a tax calculation as part of tax planning that needs to be done and it’s custom, your situation is different than your friends. And so if you’re talking about what to do here, talk to a professional about this, because this is a really big area, especially if it’s a bigger IRA. So tell them about some of the different exclusions because there’s a whole bunch from what I call this normal beneficiary.
Easan Arulanantham:
So most people will fall into this 10 year rule, say, My parents passed away, they had an IRA, they pass it to me, I’d fall into that 10 year rule. But let’s say I pass away, and then my sister is still around, and she’s with within 10 years of me, she could then choose the stretcher over her life, or the lifetime, essentially, instead of doing a 10 year rule.
Tom Vaughan:
So who, who’s allowed? If somebody is within 10 years of my age, and they inherit my IRA, they can stretch it out over their lifetime?
Easan Arulanantham:
Yes, they can do regular RMD rules, or they can decide to do a 10 year rule, they could decide which when they get
to decide, and then.
Tom Vaughan:
But *who* is it that can do that?
Easan Arulanantham:
Anyone with within 10 years. So also, there are some other exceptions to the rules. If it was like a chronically ill or disabled person, they could also stretch it. If they’re minor, it’s a bit weird, in a sense, they would be able to stretch it for until their age majority, whatever. And then after that, they would have 10 years to withdraw the remaining balance. So the idea is that you don’t want someone forced to be taxed when they’re a child essentially, say your minor, minor child inherited IRA.
Tom Vaughan:
So if a 16 year old inherits an IRA, for two years, they have to take a minimum distribution. Yeah, they could think that be very small. Yes, it’s based on age, so. And then at age 18, and beyond, they’d have to do the 10 years, and again, depending on the size, and how much difference that would make and their other incomes, right.
Easan Arulanantham:
Yeah. And so right now, the rule is, or the interpretation of the rule is, I can take, I just have to empty the account at 10 years. But the new proposed rule is, do I have to take an RMD out if there is RMDs going on from this account already. And so I would have to take an RMD each year from one through nine, as I finish the remaining balance of the year end. That is what has been pushed right now it’s proposed. But if you have a current strategy, I would stick to that current strategy, you don’t want to act on proposed rules instead of real rules.
Tom Vaughan:
Well, it’s an interesting one. So I inherit, from my parents, an IRA, that they’re already taken a requirement of distribution, that I have to keep doing that, at least that I can take out more. So if I take out the requirement and distribution, but it’s still at the 10th year, I have to get that emptied, it has to be empty. So requirement distribution at my age might not be enough to put a big dent in that I still might end up with a massive tax hit in the 10th year, which I don’t know could be good or bad, depending on your other scenarios on. So this is where you kind of have to take a look. Now that’s just a proposal to like you said it’s not, you know, in the past yet, and so we’ll see what happens there. As far as that goes, I’d probably still do the calculation to see if it’s better to take it out divided by 10 9876. Or leave it for a longer period of times and just take one giant hit. Right, depends on your growth rate, and some of the other things that you have going on in your life. So yeah, now there was another I have some clients that have a five year period, that they have to take it out not 10 years. So that’s another kind of exception.
Easan Arulanantham:
Yeah, so the five year rule is essentially if the beneficiary is not considered individual, and so it’s usually a trust. And so if the money goes into the trust, then they have to redistribute it within five years. That’s what’s the IRS is basically saying this trust is not person, we want a more accelerated rate of withdrawal.
Tom Vaughan:
This is typical. I mean, I’ve been dealing with Required Minimum Distributions for my entire career, you know, we specialize in retirement. And I have done you know, 1000s of, you know, had 1000s of people out to seminars and different things over the years. And the requirement distributions have always been ridiculously complicated. They simplified them quite a bit. And now they’ve made them complicated again, it should just be I mean, if you’re going to do all this, why have the exceptions just make, you know, make the spouse be able to take over just that’s always been the case with IRAs, but then past the spouse, everybody’s on the 10 year rule. Everybody has to take out you know, 10, nine, eight, sevens. It make it simpler, because more, but they haven’t, of course, they get some flexibility, which is good and bad. I bet you anything. We’re going to hear stories about people that don’t understand this, and they’re going ended up with this massive gain at the end of the 10 years, they didn’t even know that it existed. Because they imagined by themselves, or their advisor didn’t tell them or, you know, whatever the situation.
Easan Arulanantham:
Yeah, I think the reason they implemented this rule was essentially, the, in the past, the kind of the strategy was, give this IRA to the youngest person you have in your family, and let them stretch it for the lifetime. So it was usually going to grandchildren or someone younger than that. Yeah. So they would just have it forever. Such a small, like kind of income, they stretched.
Tom Vaughan:
Yeah, that was great, but doesn’t generate as much tax revenue. So, you know, there’s, and I’m okay with that, to be honest. I mean, you know, hey, let’s face it, you know, the government has a deficit. And you know, they’ve got to find different ways to get it. They did move the age back from 70 and a half to 72, which is a good thing. But they could have still generated income and made it clean or tax law, that they never do, actually, which is, I don’t know, that’s good for our business, I guess. I mean, because people can never figure this stuff out on their own. You know, but anyway, this is a part in, in your, you know, planning for retirement, whether you’re retired already, or you’re not retired. Tax Planning is a big one that I’m telling you, I’d say for most of my clients than what they pay an income tax is in the top five of their expenses in total. Not for everybody, but I’d say vast majority. And so that expense is something if you focus on, it’s amazing how much difference and the thing I like about tax planning my favorite part, you know, hey, we want to make sure we don’t run out of money. Well, okay, you could spend less on travel or something fun, or you could spend less on tax, and still travel. That just seems no brainer. Yet, tax planning is the most misunderstood thing, just because most of the times people do tax preparation, right? And that’s where you go to an accountant, enrolled agent, CPA, whoever, maybe you do your own, you’re basically looking at, you know, last year’s taxes, maybe this year’s taxes, we’re looking at taxes all the way out for the rest of your life, H 95. H 100. We make tweaks to it to try different things.
What happens if we do Roth conversions? What happens with the beneficiary IRAs? What happens if we do this, and we’re trying to lower taxes? Sometimes these plans actually increase taxes now, but lower taxes dramatically over the entire life of that person. Right. And it’s, that’s more money for something else besides tax. Now, again, I’m not against trying to pay taxes. I think it’s an important component of what we do here for, you know, supporting the country as far as that goes, but at the same time, it’s sort of this, you know, do you really want to overpay your taxes, and a lot of people, especially retirees are overpaying in their taxes, because they didn’t do long term tax planning. Right. And this, this question that comes up about retirement distributions, is one of the biggest aspects of long term tax planning in retirement. And, you know, if I’m 40, I’m still wanting to know about this, because I want to see how this is going to impact me. I want to know whether I should be adding to a Roth right now or a regular, you know, traditional 401k or IRA, and how different that’s going to make it and there are so many things that could really alter your tax, you know, payments throughout your retirement, just giving you more money, give it to your family, you know, anything, you know, that overpaid taxes so that anyway, that’s that’s why I think this is an important area.