Episode 47

Inherited IRA rules changed…AGAIN!

August 15, 2023

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Welcome to The Retirement Tax Podcast, where hosts Steven Jarvis, CPA, and Benjamin Brandt, CFP, work together to bridge the gap between tax professionals, financial advisors, and their mutual clients to help reduce most people’s largest expense in retirement: taxes. Each week, they will dive into conversations around taxes, focusing on what you can truly control (instead of what you cannot) and how to set yourself up financially for your future.

In this week’s episode, Steven and Ben talk about the most recent IRS notice that once again changed some of the rules on what you have to do with inherited IRAs. This notice is so recent that Ben came with the questions he wanted get answers on as well. As always Steven and Ben talk through the details but also give you tips on how you can apply this to your own situation and take action to potentially reduce your taxes over time. Listen through to the end as they cover some related topics on required minimum distributions and planning for your beneficiaries that go beyond the IRS notice.

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What You’ll Learn In Today’s Episode:

  • The current rules around inherited IRAs, RMDs, and the 10 years you have to plan
  • How you can make a better plan for your inherited IRA without any fancy tools
  • The potential savings from being proactive vs. simply letting the default happen.
Ideas Worth Sharing:

“So, it’s not only the rules by which this IRA and the RMDs have to abide by. It’s how does this fit in your own individual retirement timeline?” – Benjamin Brandt

“If you haven’t done it recently, review your beneficiaries and think about this from the standpoint of how much are they actually going to get, and is that what you had intended?” – Steven Jarvis

“Definitely wanna test out the waters literally and figuratively before you make big decisions.” – Benjamin Brandt

Resources In Today’s Episode:
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Read The Transcript Below:

Ben (00:05):

Welcome back to the Retirement Tax Podcast. I’m your humble co-host, as always, Benjamin Brandt joining me, Steven Jarvis. How you doing today Steven? 

Steven (00:12):

Ben, I’m doing great. This is the first episode that we’ve recorded since I have now met the entire Brandt Clan.

Ben (00:20):

Yep, that’s right. We spent a good part of three days in the Black Hills of South Dakota in Keystone, and we got to ride some Alpine slides and do some in the trees obstacle courses. I think if you’re following, if you’re plugged into Steven’s newsletter at some point, I think we’ll probably put some pictures out there and things like that. But had a blast. My triplets are madly in love with your daughter. She’s their favorite person on earth, so we had a ton of fun. It was great. The only downside is that I absolutely crushed a pheasant on the way to South Dakota. Then I got on eBay to find out how much new grills are on a GMC Yukon. And I think I’m just gonna have a hole in my front grill forever.

(01:02):

But that’s not what the audience is tuning in today for. They wanna learn about the same thing I wanna learn about is RMDs on inherited IRAs. Now, if you are plugged in to the hot gossip on RMDs with IRAs like Steven and I are, you know, that we’ve been round and round on these rules. First of all, we didn’t need to do anything for 10 years, then we needed to do something right away, and then we didn’t. And then lots of confusion set in after that. So, Steven is cluing me and the rest of our audience in today on some recent reclarification resolidification of what these rules actually are. So Steven, maybe you could kick us off with, you’ve inherited an IRA, it’s happened sometime in the last 18 months to two years. I know I gotta cash the whole thing out by 10 years, but, what are some of the things I need to think about as far as cash flow coming outta that account and then the associated taxes in the meantime?

Steven (01:56):

Yeah, so Ben, like you said, this has been pretty murky and we thought it got clarified earlier this year, actually, it was in December that some of that got clarified and we thought we were all set. We knew what was gonna happen, and then the IRS said, Nope, nevermind. Let’s punt a little bit further. So, up until a couple of weeks ago, what we thought was going to happen is that if you inherited an IRA, as a non spousal beneficiary, that’s an important distinction later than 2020. That’s when the rules changed over that what would happen is that you had 10 years to distribute everything, and then you also potentially had to take an RMD based on the age of the decedent. And so it was kind of this two step process of basically was the person who passed away required to do RMDs, and then the amount of the RMD would be based on the age of the beneficiary.

(02:47):

But we still had even if you had to take RMDs, those RMDs were not going to be large enough to empty the account in 10 years. So we would still, at some point, have to take larger distributions to empty this account in line with the rules. Now, what a lot of people will just kind of let happen is that they’ll only do the bare minimum and they’ll wait until the very last minute and they’ll take it all at once. And in most cases, that’s a great way to get killed on taxes because if everything else is the same and then we just spike our income all in one year, we’re pushing through multiple tax brackets. We might be pushing through multiple IRMAA brackets. It depends on a lot of factors. But I don’t like to let taxes happen by default. Even if we do the analysis and say, okay, that is what makes the most sense, great. Now we’ve at least made a proactive decision. And obviously all of our listeners come to this show because they want to learn something more. They want to do something intentional. So that’s what we’re gonna focus on.

Ben (03:42):

And to be entertained.

Steven (03:43):

Of course, to be entertained, CPA jokes are the best. They’re even better than dad jokes, as my kids will attest to.

Ben (03:49):

So the default as humans would be everything that comes outta this account is taxable. So I wanna defer that as long as possible. But what the situation that will leave us in is everything comes out that 10th year. We’ve probably had some good years of market growth if that is invested and, you know, we’re gonna be paying a lot in taxes. So we probably wanna have a better thought out plan. And if you think about at least in my, you know, anecdotal experience, the time when people are inheriting money, let’s say your parents had had kids between 25 and 30, and they’re dying at 85, their kids are at prime retirement age to receive this inheritance. So you’ve gotta think about your own personal retirement path, how that fits into those 10 years. If you’re in your last two peak earning years before retirement, it probably makes a lot of sense to take the minimum out should you be required to do so, and then take bigger chunks out almost like a Roth conversion, you know, years eight through 10. So it’s not only the rules by which this IRA and the RMDs have to abide by. It’s how does this fit in your own individual retirement timeline? And if we can sort of rearrange some of those years, we’re probably gonna save a mint in taxes. Like many things with tax planning, if we can be intentional and say, how can I best approach this over the next decade versus waiting until it’s forced upon me, we’re probably gonna save a lot of money in taxes.

Steven (05:10):

Yeah. Absolutely. It’s all about taking that intentional approach. And I, but before we move on to some tips on how to approach this for your own situation, I want to clarify that this recent IRS announcement, it came out just a couple of weeks ago. If you’re a super tax nerd like me, it’s IRS notice 2023 dash 54 if someone really wants to go read it.

Ben (05:29):

I actually have that as a tattoo. I just wanted to let you know.

Steven (05:32):

Perfect. You’ve already gotten a tattoo. So what’s relevant, there’s a lot of things that were clarified in there related to secure 2.0. But the biggest thing for this conversation is that the IRS waived the penalties on inherited IRA RMDs for 2023. That’s a fancy way of saying they punted another year to start enforcing these rules. Nothing else that I just talked about changes as far as how they intend to enforce the RMDs in 2024 and moving forward and enforcing that 10 year rule. So they’ve essentially punted. And what I’ve seen a lot of advisors respond with, just because I spend a lot of time with advisors and I’ve also just kinda seen people in general, when the IRS comes out and says, Hey, you can wait another year. A lot of people respond with super, let’s not think about it for another year.

(06:20):

And that’s the exact wrong approach because Ben, like you said, where we’re gonna get ahead and save on taxes is when we have an intentional approach. And this thankfully in this situation, doesn’t require fancy software. You can literally do this on a notepad or an Excel spreadsheet. The starting point is literally numbers one through 10, you have 10 years, and then it’s okay, what big things are gonna happen? Then you already mentioned it. This is similar to our Roth conversion conversation of how we think about these things. So you’re gonna look at your own situation and say, okay, here’s when I inherited the IRA. Well, maybe in year four I’m gonna retire and my income’s gonna drop. So maybe until year four, I’m gonna take only the minimum and then I’m gonna start really ramping that up. And maybe I’m gonna start emptying that thing as quickly as possible even before year 10, maybe because I’m anticipating social security kicking in. Maybe ’cause I’m anticipating tax rates going up in 2026. ’cause we know that’s gonna happen. Whatever that might be. But going through each of those years and saying, am I anticipating a big change or not in either direction? And of course that’s going to be a guess, hopefully a somewhat informed guess, but it gives us a much better starting place as opposed to just, well, let’s see what happens.

Ben (07:34):

Well, that’s why I love having our year end tax reviews between sort of Halloween and Thanksgiving so that we can every year set aside time, you know, pre-destined time, pre-decided time, or we can look at those and we could say, okay, here’s where we are. Here’s where we think we’re in our income is gonna be, you know, December 31st, 2023. And we could say, okay, we’ve got this amount of room before the next bracket. We’ve got this much room before IRMAA. We’ve got these things we know we’re gonna give the charity next year. We know we’re going to have to take some outta this inherited IRA, we’ve got capital gains, we’ve got capital losses. So to have a predestined time at the end of the year to say how we’ve got these five or six variables, well, how do those fit in with our retirement goals and where we think the year is gonna end up tax wise.

(08:18):

And then being hyper intentional about how we fit those pieces together. So not just looking at that year, that year is important, but also looking at the next 10 years and the scope, the full scope of retirement because, if you’re 60, we’ve got so many things to think about. 63, they’re gonna start looking at your income for IRMAA 65 is Medicare. A lot of times we switch from a self-pay to a Medicare that saves several hundred dollars a month in many cases. So, and then social security as well, it’s really lumpy. Your cash flow is hyper lumpy the first decade for most people. So that we can start to look at all these variables and say, how can we start to fit these pieces together to not overpay the IRS.

Steven (08:55):

Love that you’re bringing up so many of those things, Ben, because what I try to remind people all the time is that tax planning doesn’t happen in a vacuum, even though this episode is specifically focused on RMDs, on inherited IRAs. We have to look at all those other things you’re listing. And so again, whether it’s all literally on a pad of paper, I’m all for that, or in an Excel spreadsheet, however you wanna track it, but write out the years one through 10. Let’s get those big milestones in there. And thankfully we don’t need to dial this into the nth degree. It doesn’t need to be to the penny. Probably doesn’t need to be to the a hundred or a thousand dollars sometimes. As I’m working with clients, we also look at what’s the total amount of the IRA you inherited, especially with all these new rules.

(09:31):

If you inherit a $7,000 IRA, you might just distribute the thing and move on. You gotta look at your own situation. But rather than deal with the hassle for the next 10 years of a couple hundred dollars of RMDs, you might just distribute the thing and move on. But if this is six figures, multiple six figures, seven figures, we wanna have a really hyper intentional plan for the next 10 years because it can make a difference. It can make a sizable difference. Thousands, tens of thousands of dollars on how much you pay in taxes versus how much of that you get to keep and use for your goals.

Ben (10:00):

Yeah, I would do what you’re saying year one through 10, that’s sort of our calendar. And then I would take the total amount that I’m inheriting and I would knock a zero off the end. And that’s my annual distribution. If I do nothing else, that’s my annual distribution as a hypothetical. So I’m taking 2023 through 2033, I’m inheriting $500,000, knock a zero off 50,000, right? 50,000 a year for 10 years. And then look at your calendar, say, which year am I retiring? Is there gonna be severance? Is there gonna be vacation and a leave paid out? Is there a bonus? Maybe I wanna do the minimum that year. So then I’ve gotta add that onto all my other years. Am I gonna have market growth? And maybe I need to add that on as well. But you can at least take this some amount at some point in the future and you can start attaching that to a calendar and your own actual retirement data.

(10:48):

So years one through 10, 20, 23 through 2024, take your IRA that you inherited, knock a zero off and just put those numbers down every year. And then you can picture here’s where I’ll be at that point. I’ll be two years into retirement at this point. I think we could probably take bigger distributions this year. So I’ll probably take smaller distributions in the front end before I retire. But I should also look at how old was mom when she passed away? Was she taking RMDs? You know, what is that amount? Do I need to continue that myself? Now we know last year and this year, no, but that doesn’t necessarily mean you shouldn’t take any out. So again, a lot of moving parts here, but let’s start with the simplest possible thing. We can right. Run one through 10, knock a zero off the IRA that you inherited. Now we can sort of see what we’re dealing with. And it’s, it’s real numbers for us.

Steven (11:29):

I love putting real numbers to it. Then we get a real clear perspective on what it really means. And again, we can do simple math. It’s not hard to see why waiting to do the majority of it in one year is gonna kill us on taxes. Because if you look at the tax brackets, and especially the rates that are gonna come in 2026, if you distribute $500,000 at once and that’s before 10 years of growth you know, that’s six figures of tax bill. And some of that could easily be that you’re paying over 30% in income tax on that. So it is compared to even that out. And we also wanna think, again, bring this into what our retirement plans are. We wanna think about, are we already planning to move during retirement? Because the state implications are very different depending on where you live. And of course I always throw out the reminder of let’s make great life decisions and then figure out the tax impact. Please don’t take this as blanket advice to move to Florida just to cash out an inherited IRA.

Ben (12:22):

I think there are some people that have moved to Florida that said, you know what, I’ll take a little bit higher taxes in exchange for lower humidity. You know, definitely wanna test out the waters literally and figuratively before you make big decisions. Don’t let the tax tail wag the lifestyle dog.

Steven (12:34):

Yeah, well hat just reminded me of one of the fun things we saw when we were in South Dakota. There was that reptile zoo and all of these alligators everywhere. It makes me never wanna move to Florida, but I’m also in a tax free state. 

Ben (12:47):

But South Dakota would be on that list of tax-free states, whereas North Dakota is not.

Steven (12:50):

It would. So one of the other things I wanna make sure we cover in this conversation is the RMD aggregation rules. So now I’m throwing out all my $5 words, but it’s really important to make sure that if we do need to take RMDs, because as far as we know right now, that potentially kicks in in 2024. So it’s very possible that if you’ve inherited an IRA since 2020, and depending on the age of the decedent, you might need to start taking an RMD in 2024. And the aggregation rules is what tells us which accounts we can combine for our RMD calculation and which ones need to be treated separately and inherited IRAs have to be considered on their own. Which so Ben, if I have two or three different IRAs and then I inherit an IRA those, let’s say I have three other IRAs, I actually can just combine that total dollar amount and then I can take my RMD outta just one of the accounts.

(13:47):

The IRS doesn’t care that I can just, that they’re all in my name. I lump ’em all together. I take the distribution of whichever one of the accounts I want to, and I move on. What we’ve got to make sure we avoid is this trap of, well wait, I just got a fourth one. It’s in my name now, or my name’s on it, I inherited it. If you combine all four of those and take the distribution out of just one account, you will not have satisfied your RMD. The inherited IRA has to have its own RMD calculated and taken from that account.

Ben (14:18):

Okay, so can I aggregate two different inherited IRAs? If I inherited two IRAs from my mom, can I just take my RMD out of one of those and leave the other one alone? And then second question, if I inherited an IRA from my mom and from my dad, can I aggregate those? I’m thinking not, but I’ve never encountered this exactly the two accounts from one person or two accounts from two people that I’ve inherited. I can’t think of a time that I’ve encountered that I’d have to get on the old Google machine and figure that out.

Steven (14:49):

That’s a really interesting question, Ben. I can say with a high degree of confidence that if it’s two accounts from two separate people, they’re each gonna have their own RMD and you’re not going to aggregate them what I have.

Ben (15:00):

‘Cause they have a different date of birth, which means their RMD schedule would be different.

Steven (15:04):

Yeah, they’re that would that the same.

Ben (15:06):

That checks out in my brain. 

Steven (15:07):

Same way that you and your wife have to take separate RMDs from your own accounts and you can’t combine the two. But that’s an interesting question and I haven’t come across that in practice either. I’ve never dealt with that situation directly, that if you inherited two different IRAs from the same person, would you be able to aggregate them? So I really don’t know the answer to that. So the safe side would be No, you take them separately. Because referencing a podcast to the IRS, if you get it wrong, is not going to help your case. But that is an interesting one. I’ll have to look that one up after we’re done.

Ben (15:37):

Well, I guess tune into the next episode and we’ll have a little sidebar and we’ll reveal here’s we did, we planned this on purpose to be a teaser to have you listen. Next week’s episode is what we’ll say.

Steven (15:46):

Perfect. Ben, one other thing that this conversation brings up that’s a good reminder. We’ve been talking about, well, what happens when I inherit an IRA, one of the things that we can do to plan for the future, for the lifetime of our wealth that can set up our beneficiaries for success is making sure we use opportunities like this to review what we intend to have happen to our assets when we pass, and do we have beneficiaries set up the way we want to and what’s it going to mean to our beneficiaries when they inherit these funds? And have we had any conversations with them? And that goes really beyond just the tax implications, obviously. But that’s why you and I come on this podcast together, and it’s not just me just quoting the tax code to everyone is that this fits into a much larger conversation.

Ben (16:31):

I love it. And, there’s a lot of crossover too between the CPA world and the CFP world. And so that’s why I love the confluence of the retirement planning and the tax world, of course, to offset the biggest bill that you’re gonna pay in your retirement. Which of course is not your car insurance or your tab at reptile Gardens, it’s going to be your retirement tax.

Steven (16:50):

So Ben, like you had said before, when we’re looking at our own looking at those 10 years and putting in real dollars one thing I’ve learned from working with different financial advisors is when you’re thinking about who your beneficiaries are and what your intentions with those dollars are, it can be really helpful to put that potential inheritance to them in terms of dollars and not just percentages. Because there’s a big difference between looking at your IRA and saying, okay, I’m leaving this to Bobby and Susie and it’s gonna be a split 50% to each of ’em. Most of us don’t do a really good job of thinking of percentages. So if you haven’t done it recently, review your beneficiaries and think about this from the standpoint of how much are they actually going to get if you have a half million dollar IRA now Bobby and Susie, it’s not that they’re getting 50%, it’s that they’re each getting $250,000. And is that what you had intended? Is that your desire for the legacy of the wealth that you’ve accumulated? Is there some planning or some advanced conversations that you wanna be having as far as what happens with that, again, goes way beyond taxes, but it’s a good thought exercise to go through.

Ben (17:56):

Yeah, we’ve had that conversation with clients many times in the past. In fact, a few years ago, we set aside a whole meeting cycle to convert those percentages into dollars and say, okay, Mr. And Mrs. Klein, if you pass away today, if you both pass away today, Timmy and Susie are gonna inherit a million and a half dollars each and they’re in their early twenties, how would that make you feel? And sometimes they’re like, yeah, Timmy and Susie are more than well prepared to inherit that money. They would do wonderful things. Sometimes they say they would blow it and I’m fine with that. I’ve had that conversation, which is great. But then I’ve also had the conversation. They blow it on. I’m not okay with that. So actually we need to actually circle back to the estate documents, to the legal documents and work on that. So yeah, somebody that was averagely intelligent once told me percentages are marshmallows, it was Steven’s brother. So, percentages are marshmallows. It means nothing but we gotta convert those to dollar figures. And then sometimes those dollar figures sting, whereas percentages are just, you know, whatever. But yeah, so convert those to percentages and then ask yourself those questions. That would be my takeaway.

Steven (18:59):

That’s a great suggestion there, Ben, I like how you framed it and there’s multiple options here, and any of those options might be okay. But again, it comes back to this concept of do you have an intentional plan or is this just happening to you because it’s happening?

Ben (19:12):

Right. Yeah. You gotta say the hard part out loud sometimes. But that just because it’s hard, doesn’t mean it shouldn’t be said. So yeah. Excellent, excellent point.

Steven (19:21):

Well, Ben, this has been a great conversation. Hopefully you’ve learned a lot from it about this latest IRS notice. Tthat’s why people keep coming back and I know that we’ll always have topics to discuss because the tax codes written in pencil and the IRS changes it all the time.

Ben (19:36):

Nothing better than a little job security for us humble financial advisors and CPAs. So tongue in cheek but we love to talk about it. We love to educate people about it so they can make smarter money decisions. So that’s what we’ve got prepared for you this week. I appreciate you as always, Steven, and until next time, don’t let the tax man hit you where the good Lord split you.

Steven (Disclaimer) (19:56):

Hi everyone. Quick reminder before you go. While Ben and I feel very strongly about the information we’re sharing on this podcast, it is for educational purposes only and should not be taken as specific tax, investment or legal advice. You need to make sure that you are working with a professional to evaluate how these concepts apply to your specific situation before you take action.

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