Inherited IRAs – what you need to know

Read The Transcript Below:

Ben (00:09):

Welcome back to the Retirement Tax Podcast. I’m your humble co-host. As always, Benjamin Brndt, joining me, international man of mystery and racer extraordinaire, Steven Jarvis.

Steven (00:20):

Well, Ben, thanks for the introduction. I probably, actually, when this airs, I will have recently done an international race, so that is an accurate description. I’m going to Kelowna in British Columbia to run a Spartan race in August. So you can do the math on when we’re recording this versus when it airs, but international for sure.

Ben (00:38):

So British Columbia, is that, I can’t decide it. Is that in Columbia or in Britain?

Steven (00:43):

It is four hours north of me. That is what I know.

Ben (00:45):

 Oh, neither. Okay. Alright. It’s in the part of Canada. I can’t see from my house. Well, what are we talking about today, Steven?

Steven (00:52):

Well, Ben, one of the reasons we love talking about taxes is because it always comes back around. It always changes. We like to talk about the tax code being written in pencil, and recently, within just the last couple of months as this airs, the IRS came out and finalized. I’ll use some sarcastic air quotes, but I do believe they think they’re final this time. The rules around inherited IRAs for our listeners who’ve been following along for a while, you know that this topic has come up a few times because, geez, originally this came back up in 2019. 2020 was when the rules started changing around inherited IRAs and then the biggest moving target has been on required minimum distributions. At first, they weren’t going to have ’em, then they were going to have ’em, and then they punted a bunch of times and then nobody knew. And now the IRS has said, here are the rules.

Ben (01:39):

And they’ve waived them a few times as well. Is that right?

Steven (01:42):

Yeah, yeah. The thing we should cover most immediately is if you have an inherited IRA, no matter what the situation is as far as recently inherited IRA since 2020, there is not a RMD requirement for 2024 that’s going to be enforced. So that’s the good news in the short term. So if you were kind of on the fence with waiting for this and saying, wow, what do I need to hurry up and do for 2024? They went ahead and waived it again. And so they’re not going to start enforcement on RMDs for inherited IRAs that passed after 2020 until 2025.

Ben (02:17):

And so how can we explain this in the simplest way if possible? So if you inherited an IRA from a loved one and you’re not a spouse and you’re not a couple other things like significantly younger or things like that, but if it’s your parent, they’re 20 or 30 years older than you are, I should say in an instance where they’re leaving it to a sibling, sometimes this doesn’t apply because they’re close in age. Your parents are usually significantly older than you are. So if those are the case, if your parents started taking their required minimum distributions, then you also have to take required minimum distributions every year and you have to have the account completely empty by the end of year 10. Am I tracking so far?

Steven (02:55):

Yep. Ben, you’re absolutely tracking because the 10 year requirement was the big change. When this new set of rules came out, it was the required minimum distribution piece that kept moving. But that’s a great way to look at it. Whether or not we take an RMD is based on the age of the decedent, the person who passed away and how much the RMD is based on the beneficiary’s age. So if you’re inheriting an IRA from an aunt or uncle who to your point is more than 10 years older than you, you’re going to fall under these non-spousal beneficiary rules. You’re going to have 10 years to take it out and you may or may not have to take required minimum distributions along the way.

Ben (03:29):

It is just funny how life works sometimes, but in our office, this is a few years ago now, but I don’t remember who it was, the Secure Act or Tax Cut Jobs Act, whatever was the death of the stretch that had just passed and one of our clients had passed away that didn’t have any children. So she left her IRA to her sibling who was like eight years younger than her. And so I don’t personally read the legislation myself. It’s like a thousand pages of lawyers speak, but we go to the webinars and the conferences of the people that know how to read this stuff and they distill it down to my fifth grade reading level. But anyway, so I had gone out, I’m ready for the death of the stretch, I’m ready for this, but she was eight years younger, so everything I thought that I knew. She was part of the fine print that wasn’t that. So I had to kind of go back to square one and relearn some of these things. But I think in the vast majority of cases, you’re leaving it to your kids and they’re going to be more than 10 years younger than you.

Steven (04:21):

And it’s a cure act that prompted all these changes. And yeah, of course there’s exceptions to everything. The IRS, why wouldn’t there be? But that’s the general logic we want to keep in mind that if we’re dealing with inherited IRAs, again, we look at the decedent’s date of birth for whether an RMD was required and where this can get a little bit tricky, where I see people get tripped up is if someone passed away in their first year of being required to take a distribution because then you might fall into this trap and you say, oh, well they weren’t taking RMDs, so I don’t have to. But if you fall in that little window where they should have started later that year, then you will still need to take those RMDs. We’re getting pretty specific here because these are important details. We don’t want to get ourselves in trouble with the IRS by not taking RMDs because those are significant penalties if we miss them. But Ben, we kind of want to zoom out for a second and have a broader discussion because all this emphasis on RMD, no RMD, how much it really kind of takes the wrong focus because there aren’t any other areas of the tax code where we want the IRS to dictate to us the decisions we make and inherited IRA shouldn’t be any different.

Ben (05:31):

Yeah, and before we pressed record, we were kind of thinking about other examples where you can do something, but that doesn’t necessarily mean that you should. We’re talking personal finance topics and retirement, right? Not everybody finance, so it has to be unique to you. And inheritance is a funny thing in that, especially with everyday millionaires that you and I work with Steven, they’re financially independent at 60 and their parents might be 80 or 85, so they’re inheriting assets that they don’t necessarily need, which can be kind of tricky. So just because you turn 62, it doesn’t mean you have to collect social security. You can, but in many cases that’s not the best thing for your personal financial situation. We can maximize things and do a little bit better. Same kind of idea with the inherited IRA, yes, we have to have the entire thing emptied up at the end of year 10. Yes, likely we have to take a small amount every year as that required minimum distribution. That doesn’t necessarily mean we should operate exactly at that as is stated where I’m taking out a small amount every year and then having a big lump sum at the end of year 10. Now that’s deferring taxes and that’s probably going to have for us to have a smaller tax bill year one through nine, but then we’re definitely going to have a big tax bill at the end of year 10 because if we’re still invested for growth, we’re probably having a bigger balance at the end of year 10 than we started with at year one because we’re taking out two or three or 4%, whatever that is, and it’s growing hopefully more than that. Even if you’re in a money market, I think at this point it would grow outgrow what you’re taking out. So that’s where we want to get hyper personal and say, okay, you are financially independent. Maybe you’re retired or near it, or you’ve been retired for a few years. We know that we have to cycle through this entire account. What’s the best way that we can add these new set of rules into what we’re already trying to accomplish, which is have a lot of income, spend a lot of income, not get killed in taxes and all that kind of fun stuff we talk about all the time. So I think for many clients it’s not going to be take the minimum for 10 years and then cash out this huge amount at the end, it’s going to be more of a Roth conversion style strategy to say, here’s where my income was this year, it was 110,000. Here’s the Irma brackets I need to be concerned about. Here’s the tax credits or deductions or something that may phase out at this income level. Could I take an additional $30,000 out of my inherited IRA this year and then spend it or reinvest it? But that’s going to get me closer to having that thing completely emptied out at the end of year 10. So as I have this new asset, it plays by new set of rules, here’s the things I have to do and the timeline, I have to do it now, how do I make that unique to my situation and overarching theme, not get killed in taxes so it adds a few layers, which is makes for great podcast content and makes for some great job security for us. But it’s simple in the idea that cash the whole thing out in your tent, take annual payments, but it’s complicated in that there’s a lot of nuance into how do we take this money out.

Steven (08:23):

Ben, I like that you brought up just a general Roth conversion strategy because that’s something we talk about much more often on this show, but it is the same general logic. It’s kind of taking that moment to say, Hey, am I concerned at all that taxes might be higher in the future for me personally, whether because the tax cut and jobs act is expiring, we think that whatever political wins are happening will result in increased tax rates or because we might have higher income in the future, which that’s not a natural conclusion when we’re retired that hey, my income might go up. But yeah, as our loved ones get to that point where more of them are passing away and they’ve also done a great job saving for retirement, these are just realities of the people that you and I work with quite often. And so thankfully we don’t have to get so into the weeds that we need some complex piece of software to model this out into every possible combination of outcomes. Even if we literally start as simple as back of the napkin, I would love it if someone sent me a picture of a literal back of a napkin they did this on personally, I’m going to do it on a notepad or maybe in an Excel spreadsheet, but it’s 2024. And then we’re looking for major events. What do I know is going to be happening where my income might be higher or lower that I might take that extra 30,000 or I might pass on that 30,000 in a particular year so that I can maximize my tax brackets in those given years. So I’m looking for things like social security starting or retiring or tax cuts and jobs act expiring. Is there another pension that’s going to kick in? Am I already planning on selling a house or a piece of property or moving these other things that might also impact my income? And the great news is with an inherited IRA this, there’s a lot of discretion on the timing of the money we take out of there. So we can wait until late in the year and say, Hey, what else has gone on? And now let’s check back in on my 10 year plan and say, okay, that’s right. I’m expecting social security kick in two years when I turn 70 or whenever I’ve decided to start taking that. So maybe I do front load a little bit more of those distributions to keep that in lower tax brackets.

Ben (10:33):

Yeah. I also look at, are you 63 yet? Is the IRS keeping tabs on your Medicare age? IRMAA really starts at 65 when we sign up for Medicare, but really they’re looking at your income from 63. So if you have a big inheritance at 61, you could say, well, simple logic would say, I want to defer those taxes until 71 just because for whatever reason. But if we could actually get all of that money out of your IRA at 61 and 62, well then we could maybe save several hundred dollars or maybe a few thousand dollars a year in IRMAA savings and maybe we can move some things around to get that money in your IRA or your Roth IRA by paying some taxes with the inheritance on your traditional ira. There’s many different layers of things that we could do, but just defaulting to minimum payments and cash at the end, I think that’s a recipe for more taxes. But I couldn’t say to every single 330 million Americans, but I’d say most of the time we’re going to pay more taxes doing it that way.

Steven (11:28):

Yeah, and Ben, in my experience, what happens when people don’t have an intentional strategy? There’s one of two things. One is that they messed this up right out of the gate. And the way I phrase this is, or kind of the question I ask is, did you inherit an IRA or do you have an inherited IRA? And the distinction here is if my uncle passes away and leaves me this money, I have to make sure it’s handled correctly. If I not really thinking about it, I cash that check and then decide, Hey, what am I going to do with it next? Well, I’ve just taken it out of the IRA, I’ve just created a taxable event. I didn’t work alongside someone who can help me with the nuance of making sure I get to take advantage of those 10 years. So we see that at times that people inadvertently take it all in year one and get killed in taxes. I’m a numbers nerd, so I’ve got Excel spreadsheets where I’ve run this before. And even if we just very simplistically either take it all in one year or spread it evenly over 10 years depending on the size of inherited IRA, this can be tens if not hundreds of thousands of dollars in taxes that we pay different depending on those situations. Almost always more favorable to spreading it across multiple years. The other end of the spectrum then of course would be I inherit an IRA and then I don’t do anything with it for 10 years. I take it all out all at once in 10 years. And again, I get killed in taxes all at once. And so we don’t have to get this perfect. We don’t have to dial it into the hundreds of dollars or tens of dollars in a given year, but doing something intentional year over year is likely going to save us five or six figures in taxes.

Ben (12:59):

Most retirees don’t realize they’re going to pay a high six figure or a low seven figure total tax bill. So again, if we can sand off the rough edges, that’s real money. Several thousand dollars here is several thousand dollars there pretty soon it’s real money. I would also say that now where that we’re thinking about inheritance and inherited IRAs, have a conversation with your parents. I know that the vast majority of our listeners are nearing retirement, which means their parents are nearing average mortality. Have a conversation with your parents about these new rules and how they might apply it to you as the person inheriting the money. There could be a situation where it would be appropriate to review the beneficiaries on your parents’ IRA and include contingent beneficiaries because you might be in a situation, the person listening to this podcast where you don’t want any more assets for your retirement. You’ve already overs saved, overshot the mark, and we’re already doing Roth conversions and all the things that we can do to rightsize your tax bill if you inherited it, another $300,000 on top of that, that’s just a lot more taxes that we’re going to pay. And you might not need the money. Might not want the money. So if we can review the beneficiaries and the contingent beneficiaries, there could be a situation where you might just disclaim the assets saying, yes, I’m the beneficiary, but I’d like to just continue that on to the contingent beneficiary, which is my son and he’s 37, and he could actually use the money a lot more than I could financially independent. I’m speaking hypothetically, my son is 12 and he’s not financially independent, surprisingly. So something to think about if this can foster a conversation. I visited with a woman the other day, her name is Myra, and she specializes in second generation for inheritance for ultra high net worth. And her theme is no surprises. You always want to have a situation where there’s as little surprises as possible, and the only way you can really get there is through communication. I know politics, sex, and money are the three things we’re never supposed to talk about, but it’s probably a good idea to have some idea if you’re going to inherit some just so you can make plans for yourself.

Steven (14:52):

And there is always the option that you can make voluntary contributions to the national debt. So if your goal is to pay as much in taxes as possible, we can also really simply facilitate that. Although no one’s ever taken me up on that and I haven’t actually personally made a voluntary contribution to the national debt. Maybe I should like a dollar or two just to say I’ve done it and know how it works.

Ben (15:11):

Maybe we should do that. Maybe we should make a short form video where we give a dollar to the, because I imagine that it’s got to do something like put you on the no-fly list or get you off the no-fly list or it’s got to do something. No one’s ever done it that I’m aware of. So something, there’s got to be an Easter egg where I get a card from the IRS or something. Right.

Steven (15:28):

Alright, Ben, in a future episode, we are going to share what our experience was contributing to the national debt or contributing to the payment of the national debt. I’m sure we make all sorts of contributions to increase in the national debt. Before we move off this topic of disclaiming assets, I think a year or so ago, you and I did a whole episode on this. It is a great topic if you’re in that situation where we’ve got multiple generations that we’re considering, and Ben, to your point, there’s some things you need to do upfront as far as making sure how contingent beneficiaries are named, things like that. This isn’t something we can do after the fact, which obviously there are more important things in life than taxes and money, but we’re going to create better life experiences if we’re being proactive and even having uncomfortable conversations at times because sometimes we literally get to a point where it’s too late to do anything about it.

Ben (16:17):

That’s right. Yeah. So I think if you could attach it, an overarching theme to all this stuff that we talk about proactive is better than reactive. Anytime that we react and say, this is the situation, I may now I have to make a decision, it’s just never going to be as good or as well thought out or as well planned of a decision if we, not that you can anticipate everything in life, but if we try to anticipate this thing and we have the market going down right after you retire, we hope that that doesn’t happen. But that’s the thing that we could anticipate and then we could create contingencies. We’re going to pivot, we’re going to do this, that or the other thing. Anytime we can be proactive is better than being reactive.

Steven (16:52):

And then right along with that, Ben, I mentioned it a little bit earlier, but especially when we talk about taxes, just assume that whatever the default situation is is going to be the worst situation for you because I can assure you that the IRS is not writing rules in your best interest. That’s just not what they’re asked to do. I am not even trying to imply that the IRS is full of nefarious people. That’s just not their job is to write the rules in a way that’s best for Benjamin Brandt. And so don’t let the default be what you follow through on, take the time to understand enough. And at the very least, you’re listening to Ben and I talk about these things on a podcast on a regular basis, so clearly you care. So we need to turn that interest into action. And again, this can be as simple as, Hey, what’s the next 10 years look like? Just real high level, what are some big events? And then how do we make decisions based on that? The default is very unlikely to be the best outcome.

Ben (17:48):

Right? Right. Yeah, back a napkin is great. I like the most powerful retirement planning software in the world, which is a spreadsheet. So you just say my age 58, go 58 to 78 and just, you don’t even have to make fancy calls, but just say, okay, I think I’ll start social security here. I know that I’m starting Medicare here. They’re going to keep track of my income here. Spouse, a social security. You could just 10 cells, 10 to the left and 10 south. You could figure this out, I think, pretty accurately and say, oh gosh, okay. I’m actually much better off spending more from my inherited IRA early on, or maybe it is better for me to defer because of X, Y, Z deferred compensation plan or something like that. But I think the moral of the story is you’re doing this thing because you intentionally calculated it and you’re acting on a plan, not taking life as it comes and making a decision in the moment.

Steven (18:39):

Absolutely. Well, Ben, we’ve kind of started the last couple of episodes teasing things to come next. So I don’t want to ruin that trend. So as we talk about having this roadmap of what those big life events look like, be sure and tune into the next episode. We’re going to talk about things you should be thinking about between now and the end of the year because 2024 is going to be over before you know it. So next episode, we will be talking about those things to be thinking about in the 90 or so days that’ll be left in the year at that point to make sure that we’re making this as actionable as possible. So I’ll look forward to the next episode with you, Ben.

Ben (19:12):

Well, that sounds good. Well, here’s a teaser for the next episode. So the next episode, I’ll be a year older. So see if you can hear the difference. So that’s what we got prepared for you this week. If you love it, share it with a friend. And until next time, don’t let the tax men hit you or the good Lord split you.

Steven (19:25):

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.