December 2024
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Here are some key takeaways from their conversation:
- In 2020, Secure Act 2.0 made it so non-spouse beneficiaries must fully deplete inherited retirement accounts (traditional or Roth IRAs) within 10 years, instead of stretching distributions over their lifetimes.
- Starting in 2025, individuals who inherited IRAs after January 1, 2020, must begin taking annual RMDs within the 10-year window.
- Beneficiaries need to consider their income levels, tax brackets, and financial plans when deciding how much to withdraw annually to minimize taxes and maximize financial benefits.
- Spouses have unique flexibility, such as rolling an inherited IRA into their own account to delay RMDs or treating it as an inherited IRA to access funds penalty-free.
- Minors who inherit IRAs can use their life expectancy for withdrawals until turning 18, after which the 10-year rule applies. Withdrawals can impact eligibility for student aid or repayment plans.
- Individuals aged 70.5 or older can make qualified charitable distributions (QCDs) directly from inherited IRAs to reduce taxable income while fulfilling RMD requirements.
- Failing to take an RMD incurs a 25% penalty, which can be reduced to 10% if corrected within two years. Beneficiaries must stay on top of annual distribution requirements.
Watch previous episodes here:
Ep. 117 Hidden Gems in Real Estate Investing
Ep. 116 Time's Running Out: Financial To-Dos Before 2025
Hello, everyone, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. Here to join me today as Wealth Advisor Patrice Bening. I'm so excited to have a conversation around inherited IRAs, the confusion and the frustration of this rule change in 2020. I mean, it's a hard concept for people to really grasp, but we're going to break down some of those changes that apply to people who inherited an IRA after 2020 and what some of the rules are now going forward with regards to required minimum distributions.
Are you excited?
Very. I mean, I think it's probably... that's all we can hear buzzing around the office. It's funny, this morning driving here today knowing that we're going to have this discussion. I was in the car with my 17 year old and I said, I'm going to talk about required minimum distributions today. And he said, what?
And I said, do you know what an IRA is? So now I failed as a parent who is in the financial planning world because my 17 year old son does not know what an IRA was. And ten minutes into the conversation, he's very confused on a what an RMD. So I hope we can do a better job today.
Yeah. I, I feel your pain. Although, you know, you got to give him some grace. He is only 17. And he's an incredible kid. But at the end of the day, I felt like talking about required minimum distributions and inherited IRAs became, you know, fairly simple during the course of my career because, you know, when somebody inherited a retirement account, they had to start taking out a minimum required distribution and they could stretch it over the course of their life.
And so it was really simple. It's like, what's the 1231 value? Look up the life expectancy, calculate it, and you know send out that amount. If people need it more they could do it. And then you fast forward to 2020 and the rule changes.
Right. Secure Act 2.0. Gotta love it. So now if you're a non spouse and you inherit a retirement account, whether it's an IRA or Roth IRA, you now have to distribute all of those assets within a ten year period. So if the account's $1 million, by the end of year ten, it's got to be zero balance.
Right? So what the interesting point about this is that the reason we're having this discussion is that even when the Secure Act was passed, there was no guidelines from the IRS saying, okay, everyone has to take out X amount, you know, to make sure that in the next ten years, we know that the next ten years we had to deplete it.
But there was like, take it if you want to, but you don't have to. So four years went by with this. We're not sure what's going to happen. And guess what 2025. Now it's mandated that if you inherited accounts after 2020, you have to take a required minimum distribution and you have to deplete it within ten years.
Right. And some clients are kind of asking us, well, how much do I have to take out? And that depends, right? It depends on whether or not the person you inherited it from. Was subject to required minimum distributions. It depends on your age. It depends on your income and whether you should take out just a little bit or more.
But an example of that. I've got a client who is call it, you know, 59 years old. He inherited this, this retirement account in 2020 from his father, who passed and the balance today is call it $1 million. So next year, he's going to have to take out at least $40,000, give or take a year next year. So he's got six years left to deplete this retirement account.
Well, that retirement accounts $1 million. So if he only takes out 40 or $50,000 a year, the next, you know, five, six years, that last year it's that IRA could be worth $800,000. And that's a really big income year. So like we need to be more strategic and thoughtful in terms of what their income situation is like, how much they should take out.
If they're still working, maybe you do just take out the minimum. If they're not working, maybe you can take out more, but you've got to be more strategic. And I know you've got some examples like that.
So I think like to your point, we did a financial plan for, for one of my clients where he inherited an IRA, while he was still working. And it was easy, I would say, because it was a 2021. So and, you know, when we looked at it, I said, you don't have to take a required distribution, kind of let's see.
He knew he was going to... he was about two years away from retirement. So that's why we dive into the financial plan. Did not anticipate for his parents to have passed. But I would say that when we looked at kind of the how to be strategic, we kind of look to see once he's retired, there's really active income went away.
We were looking at the portfolio, how that was going to supplement his lifestyle. But now that he inherited retirement assets that did not come from a spouse. We looked to see, based on his marginal tax rate and where and based on his other income that he was slated to receive is filling in that tax bracket. So if you're in the, you know, 22 or, you know, 27 or whatever, that 32.
So it's like being strategic that way. So because even the required minimum distribution is still based on your own life expectancy, but you still have ten years depleted, which kind of goes back to your story of it's not going to ever be enough. So it's not a blanket decision that, you know, anyone should take. You can be very intentional on how much you should be taking every year.
I like that example. I mean, obviously timing with not really being forced to take distributions last few years while your client was working, when they do retire, they could take out a larger amount and be in a much lower tax bracket than if they were forced to take out money while they're still working. And so that's a good way to be strategic.
I had another situation where a spouse actually... his spouse passed away, and his spouse was closer to required minimum distribution age than he was. So we chose just to take her IRA and roll it into his as if it now became his IRA. And it gave him an extra few years before he's forced to start having to take distributions.
So, you know, there's different rules for different people. I think the net of what we're trying to get to today is you've got to be strategic and there's a lot of options. What are some other examples that you can think of?
I think spouses, you know, you've got a very unique position to do a few things. So, for example, I think we don't think about, let's say, on the Roth IRA side, we love Roth IRAs. They're the best IRAs. And I think even from a legacy and planning, that's usually what we advise clients to be able to do that and even do Roth conversions early on.
But that's a different story. So say, let's say if a spouse inherits a Roth IRA, there's actually you have the opportunity... if you already... so let's say if my husband passes away and I inherit his Roth IRA and I already have a Roth IRA, I can take his and add it to mine. And let's say I'm still working.
I can, let's say I'm eligible to make Roth IRA contributions. I can continue adding to that particular Roth IRA. So this is a not inherited IRAs did not have.... you cannot contribute to them. Right. That's a blanket rule except for spouses who choose to assume it.
Now taking money from it. I have to be 59.5 and I've had to have that IRA already for five years or more. So nuances on that level. But some, you know, some fun things that we can, we can consider as well.
Yeah. I mean, that's a good point because if somebody actually needed the money, they might want to not assume that that inherited Roth IRA to become their own. They might have it be an inherited Roth IRA where they can take distributions and not be subject to penalties if they haven't owned one for more than five years, or if they weren't over 59.5.
That's a good example. There was another example that we were talking about a few minutes ago where the spouse who's older, you know, passes away and you could sort of take that and assume it as your own and, and delay having to take required minimum distributions for that. Like, what are some situations where, you know, a spouse might want to leave it as, as an inherited regular IRA to take distributions?
I mean, what what can you think of there?
So I think it's because I, I thought of this the opposite way too. I think if, if the spouse is younger. So let's say you have a husband and the wife and let's say the husband is 50 and the wife is 60, and let's say the husband passes away. Yeah. The required minimum distributions start at age 73 if you're in 2024.
Correct. So if the spouse who inherits that IRA, she's ten years older, she's closer to that RMD age. So she rolls over the inherited IRA into her own account. That time period, she's going to accelerate because she's going to become 73 sooner. But she can choose to keep it as a separate inherited IRA. And at that point, she can wait until her husband would have become, you know, of required age to take that distribution.
And so that could be basically 23 more years instead of 13 years for her.
Yeah, that's an interesting one. Like, what about kids? Like, sometimes we have minors or kids that inherit retirement accounts. What are some strategies or things that you can think of for them? Like what? What how did these rules apply to them?
So kids typically are not subject to the ten year rule except so depending when they inherit. So let's say if you're a ten year old and you inherit something from a parent or grandparent, let's say you don't have to use, you can still use your life expectancy. However, the moment you become of maturity age which is 18, then you're subject to the ten year rule based on the life expectancy.
So that's interesting. So if somebody that's ten years old is the beneficiary of an IRA, they don't have to... even though the new rules say ten years, they don't have to take any distributions until they turn 18. And then it's looking at their life expectancy. And then they've got ten years from that point to take it out.
Yeah. But that could cause some problems if they're young and they need student aid or student loans for schools.
Let's say that you are looking to, you know, apply for college and do anything that comes outside of an IRA is earned income. It's taxed at ordinary tax rates.
So there's nothing you can do to go around that. So even if you don't make any other income, you're thinking, oh, I'm fine. You know, I should probably get some nice... I'm going to go to college. I think I'm going to get some nice package because I don't have a lot of income. And like, if you inherit a really big IRA.
And now to your point, you have to take out $30,000. That's $30,000 of income that, you know, you have to report. So that can hinder your ability to qualify for more aid. And then on the back end, let's say you're probably in your, let's say 20s, you've graduated college, but you have student loans. And even with the new income-driven repayment plans that are available out there, because they are income driven and the IRA distributions count as income, that's another part of where you have to be very careful to see, you know, which years can I just, you know, maybe only for the next 3 or 4 years I take the minimum required and then I take a bigger chunk later. So planning around that I think is very important.
Yeah. You bring up a good point with regards to the income driven student loan repayment. Taking out just the minimum or taking out more could really affect how much you know, you have to pay back.
Yeah. Obviously, when looking at this new ten year rule for non spouses... So some of these forced to have to take distributions over a ten year period. You want to look at you know their need for qualifying for higher education and help what the income is for their, their Medicare payment.
So if they're older right. I mean having to take money out of an inherited IRA affects your income, which affects pricing for Medicare premiums. But then also your tax rates as well. And, you know, for people that sort of have lumpy income years, you can be a little bit more strategic year over year because it's not that simple.
If you inherit, you know, $1 million IRA, it's not like you have to take out $100,000 a year. It might be a lot less than that, depending on your age. And so you want to be in a situation where you optimize the tax and the net, you know, amount back to you.
And also, I think, you know, we talked about this, if you're, let's say, at a point in your life where you know, you have significant assets, you have really solid income from various sources and you're charitably inclined. Typically we do this on a regular basis with clients that if you're already 73 years old and you yourself are subject to required minimum distributions, you can take, you know, part or all of it up to 105,000, let's say, for 2024 and give to a qualified charity.
And then it's like a qualified charitable distribution. Correct.
So that one will not that one will basically check the box for you satisfying your distribution. It will not be taxed because it's going straight to the charity from your IRA. So so that's the typical situation. So can you do that if you inherited an IRA. And let's say you are, you know, over 70.5 which that's when you can technically make those qualified charitable distributions.
You can actually use that on the exact same purpose. So it is very maybe kind of thoughtful if you don't need that income. And you want to just, you know, make sure that you don't trigger like to your point, higher Medicare premiums and you are charitably inclined. That's an option.
And if you're under 70.5 and you've got extra income that you're subject to because of the required minimum distributions on inherited IRAs, you might want to work with your CPA or your advisor around other strategies that you could deploy from a charitable standpoint to help, you know, reduce or limit some of that tax liability. Absolutely. Yeah, those are really good points.
It gets so confusing. But the net answer of this conversation is people now in 2025, if you have an inherited IRA that you inherited after January 1st, 2020, you are now forced to start taking minimum required distributions next year and going forward. And so you have to still follow that ten year window. If you forget to take a distribution, the IRS is going to be pretty firm on this and not waive penalties going forward.
It's a 25% penalty for that mistake.
So you can fix the mistake and the IRS will reduce that to 10% if it's done within the next two years after you forget to do it, but you still pay a penalty, so it's not forgiven, it's just reduced, right?
So in that example, if you know, the client's call it 59 years old, has $1 million inherited IRA and they're forced to take out around $40,000 next year if they forget it's about a $10,000 penalty, but they still have to take the money out and pay income tax on it. But you have a couple year window where you can you can make up for that distribution, and it's just a 10% penalty.
So in that example it would be like a $4,000 penalty.
Yeah I don't like giving money to the IRS you know period. So I definitely want to make sure that, you know, clients don't miss out on, on taking that required minimum distribution. Patrice, any other thoughts or points that, that that we might have missed as it relates to the new rules and how it applies going forward that you can think of?
I think it's understanding the timeline also. You know, that's why we're in the thick of it now. December 31st is the absolute last day. You know, if you inherited retirement accounts, that you can take money out. So, understanding, you know, how you got that money, you know, if it's from your spouse or is it a parent?
And then how you have to treat those distributions and understand that it's a very thoughtful decision, that you know, that you should put some more, you know, planning into it and talk to your advisor, talk to your CPA as well, so that we can really think about like what years, how, you know, how fast should you accelerate, should you defer also how that account is invested.
Probably going to, you know, look at the underlying investments if there's any decisions around that. But just don't don't delay it and don't think that, you know, you can just skip it. It's not worth it.
Yeah. No, I love that point. Obviously, the whole purpose of this is to be strategic and thoughtful because you have options. You can be very creative with some solutions that you can deploy. And I really enjoyed this conversation and thank you so much, Patrice.
Thank you, Chris, for having me.
Information presented herein is for educational purposes only and is not intended to constitute financial, tax or legal advice. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. It should not be assumed that Morton will make recommendations in the future that are consistent with the views expressed herein. Information contained herein is not written or intended as tax advice and may not be relied on for purposes of avoiding any federal tax penalties under the Internal Revenue Code. You should consult with your finance professional, accountant, or tax professional before implementing any transactions and/or strategies concerning your finances.
