Inheriting IRAs - More Limited Options | Series 3.6

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Welcome to the enjoy more 30s family finance

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podcast. The only podcast dedicated to making life more

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enjoyable for young families. By hitting on the financial topics

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that tend to weigh on us stress us out and distract our focus

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from simply enjoying life.

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Welcome to the sixth episode of Your Parent's

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Money Mindset series. Last episode, we covered the current

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rules governing non retirement accounts that can avoid

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potentially significant taxation. Today's episode is

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titled Inheriting IRAs, More Limited Options, where we will

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cover some rules this time for inherited IRAs, as well as the

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more recent approved changes or changes that have already gone

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through that caused significant limitations now in your options

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going forward when it comes to inheriting IRAs. You'll learn

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today what you need to know about what key points the new

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rules changed, and once again, what you can do and help your

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parents to be aware of to possibly adjust for it. My son

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Noah is currently one and a half years old and a huge Cookie

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Monster fan. Cookie comes out of his mouth every morning to put

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on an episode of Sesame Street with Cookie Monster in it. And

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if you've ever watched Sesame Street before, they do have a

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lot of clever parodies that they work in to try to keep the

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adults watching along entertained. One in particular,

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goes off the Harry Potter series and where Cookie Monster plays

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Furry Potter needing to follow Professor Crumble Moore's

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directions for completing the tasks and getting of course a

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couple of cookies. As the skip goes on the rules change each

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round, though, of which Cookie Monster obviously doesn't pay

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any attention to causing him temporarily at least to be

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rather frustrated with the process. I'm always thinking

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halfway through the episode poor Cookie Monster, I guess really

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Furry Potter, I suppose. He keeps having these rules changed

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on him all of a sudden and that's not exactly fair. So what

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you need to know is that inherited IRAs got furry

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pottered, so to speak at the end of 2019 with the Secure Act. You

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probably didn't hear about this, because towards the beginning of

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2020 COVID happened, and the Secure Act wasn't exactly top

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news anymore. What changed is that previously an inherited IRA

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could be stretched out for that person's entire life. So let's

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first tackle that first word I use stretched. What does

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stretched mean? It means that you would only be required to

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take a small portion every year out of the account. This

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required amount referred to as an RMD, or required minimum

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distribution was based on your life expectancy. As a child of a

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parent, you were younger, which made these distributions pretty

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minimal in most cases. Having very minimal required

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distributions is a good thing. Because the amount that is

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distributed is fully taxable as ordinary income. Less

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distributions means less tax. Now, the rules require you to

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take out all of these funds within 10 years. So your initial

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thought might be like, 'Hey Joe, you know, 10 years isn't so bad.

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Why is that really such a big deal compared to the old rules?'

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If you took the funds equally over 10 years, that would mean

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that every year you're taking 1/10th of the account, so 1/10th

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distribution per year. Under the old rules, a 50 year old would

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only need to be taking out around 1/34th per year, so a lot

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less. The other big point is that if you inherited at 50,

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you're probably still working at 60 for this new 10 year window.

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So now all this income is going to be realized most likely

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during your highest income earning years while you're still

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employed. This means that distributions are going to hit

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you in the top income tax brackets wherever you may fall,

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or push you into even higher ones. If you are of the mindset

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that tax rates are going to go up over time, by the time this

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happens to you, the top income brackets could be even higher

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today than today as well. The last part of this puzzle is not

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to forget that the assets are growing in your parent's

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accounts in the meantime. So whatever the tax liability might

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be today that's going to hit you, it's growing and growing

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and compounding as time goes on. A $200,000 IRA inheritance today

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might be worth $400,000 10 years from now, when your parents may,

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let's say pass away, all fully taxable as ordinary income to

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you needing to be taken out over a 10 year period of time. So

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what can you do? There honestly aren't a ton of options for you,

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but the main possibility is off of the last part of the puzzle I

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just mentioned. How or more precisely where your parents are

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going to be leaving these assets to grow. Let's say your parents

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had that $200,000 IRA, like we just had in the previous

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example. That means that maybe 20% of it, or 40,000, is owed to

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Uncle Sam. And that's just kind of a way to keep the math a

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little bit simple. If in 10 years, that account grows again,

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like we just talked about before to 400,000, that tax liability

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number now also doubles to 80,000, using that same 20%

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rate. And again, that's assuming tax rates do not go up in the

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future. And like we've kind of alluding to before, if you

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inherit it, during the height of your working years, 10 years

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down the road, it would be on your tax bracket. So maybe,

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let's say that could now be even higher, maybe as high as 30% and

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we're jumping all the way up to $120,000 now in taxes that's

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going to be due on this IRA. So 40,000, today might translate to

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$120,000 in taxes due 10 years from now. And as we're all

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wanting our parents to live nice, long lives, this might not

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be 10 years, it might be 20 years, 25 years. So you could

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see how this really could build up and be a very, very large tax

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liability down the road that you might be having to pay at some

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point. This growth, remember is happening regardless. But what

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if we can kind of change where it is growing? If your parents

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do small, what are called Roth conversions every year so moving

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part from this traditional IRA, into a Roth IRA, the Roth IRA is

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going to grow tax free. The amount of the conversion, let's

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say they converted 5000, that 5000 that's converted would be

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taxed today and your parents would have to be paying that tax

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today. If they're able to pay the tax on that now, in their

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maybe lower retirement brackets potentially and in addition to

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that, now all the growth is going to be tax free. So again,

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it is going to grow regardless, so a case can certainly be made

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for paying the tax today, so that future growth can be tax

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free. So let's just say as another example, just to further

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illustrate that point, we had the $200,000 IRA. If we looked

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at it right now with a 20% tax bracket, that would be $40,000

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in tax. Let's say that all of that was converted today that

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$40,000 was paid not recommending that, but just

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again, keeping the math simple. Now when that $200,000 account

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reaches $400,000, in 10 years from now, all of that now is

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going to be tax free to you. So that's a really, really, really

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big difference. Inherited Roth IRAs still have to be

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distributed fully in 10 years as per the new rules. However, you

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can just wait until year 10 build up as much tax free growth

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as possible, and cash out without any tax implications

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whatsoever. Whether or not this is a good fit for someone

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absolutely requires some additional planning though; what

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investments they may need or not, what funds they may have on

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the side to help in paying the tax, or even if minimizing taxes

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paid to Uncle Sam for their children is even a goal. Maybe

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this is just too much of a hassle for them and they could

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be of the mindset of whatever they get when I'm not here is

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what they get. And honestly, that's fair too. For those that

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do have it as a goal though, it can really be a well worth

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discussion, potentially saving 10s of 1000s of dollars in taxes

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paid over the long term.

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So the recap for today is realize that inherited IRAs or

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retirement accounts have unique rules if and when you inherit

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them. However, your parents do still have some powerful options

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in minimizing that tax potentially. Ask your parents

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'Did you hear about how they significantly changed the rules

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for for people inheriting IRAs? Do you know if your plan is set

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up to properly try and help minimize or reduce these total

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taxes being paid long term, mom or dad?'

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Thanks very much for tuning in today. As always, if you're able

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to implement what we're covering, then that's always

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fantastic. You have less to worry about than before and you

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can focus more on enjoying life today. If you are wanting help

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with these things though or have questions you need help and

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clarifying check out the Ask Joe section on the show's website

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www.enjoymore30s.com that's enjoy more three zero s.com. If

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you enjoy this specific episode, please make sure to subscribe

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and review us on Apple podcasts or wherever you listen. There

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are literally millions of young American families out there I'm

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trying to reach and help just like you. The next episode is

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the last in this Your Parent's Money Mindset series, titled

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Retiree Healthcare for Parents, A Lot Is Not Covered, where

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we're going to share some basics on Medicare, Medicaid, and

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probably most importantly, what they don't cover when it comes

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to long term care. Until next week. Thanks for joining me

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today and I look forward to connecting with you again soon.

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The conversations on this show are

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Joe's opinions and provided for general information purposes

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only. They do not constitute accounting, legal, tax or other

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professional advice for your specific situation. You should

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always seek appropriate advice from a financial advisor,

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accountant, lawyer or other professional before acting upon

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any content or information found here first. Joe is affiliated

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with New Horizons Wealth Management, LLC, a branch office

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of TFS Securities Inc. and TFS Advisory Services an SEC

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registered investment advisor member FINRA/SIPC.