The 2019 SECURE Act drastically changed how IRAs are inherited - how much will this affect you?
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Joseph Okaly:Welcome to the sixth episode of Your Parent's
Joseph Okaly:Money Mindset series. Last episode, we covered the current
Joseph Okaly:rules governing non retirement accounts that can avoid
Joseph Okaly:potentially significant taxation. Today's episode is
Joseph Okaly:titled Inheriting IRAs, More Limited Options, where we will
Joseph Okaly:cover some rules this time for inherited IRAs, as well as the
Joseph Okaly:more recent approved changes or changes that have already gone
Joseph Okaly:through that caused significant limitations now in your options
Joseph Okaly:going forward when it comes to inheriting IRAs. You'll learn
Joseph Okaly:today what you need to know about what key points the new
Joseph Okaly:rules changed, and once again, what you can do and help your
Joseph Okaly:parents to be aware of to possibly adjust for it. My son
Joseph Okaly:Noah is currently one and a half years old and a huge Cookie
Joseph Okaly:Monster fan. Cookie comes out of his mouth every morning to put
Joseph Okaly:on an episode of Sesame Street with Cookie Monster in it. And
Joseph Okaly:if you've ever watched Sesame Street before, they do have a
Joseph Okaly:lot of clever parodies that they work in to try to keep the
Joseph Okaly:adults watching along entertained. One in particular,
Joseph Okaly:goes off the Harry Potter series and where Cookie Monster plays
Joseph Okaly:Furry Potter needing to follow Professor Crumble Moore's
Joseph Okaly:directions for completing the tasks and getting of course a
Joseph Okaly:couple of cookies. As the skip goes on the rules change each
Joseph Okaly:round, though, of which Cookie Monster obviously doesn't pay
Joseph Okaly:any attention to causing him temporarily at least to be
Joseph Okaly:rather frustrated with the process. I'm always thinking
Joseph Okaly:halfway through the episode poor Cookie Monster, I guess really
Joseph Okaly:Furry Potter, I suppose. He keeps having these rules changed
Joseph Okaly:on him all of a sudden and that's not exactly fair. So what
Joseph Okaly:you need to know is that inherited IRAs got furry
Joseph Okaly:pottered, so to speak at the end of 2019 with the Secure Act. You
Joseph Okaly:probably didn't hear about this, because towards the beginning of
Joseph Okaly:2020 COVID happened, and the Secure Act wasn't exactly top
Joseph Okaly:news anymore. What changed is that previously an inherited IRA
Joseph Okaly:could be stretched out for that person's entire life. So let's
Joseph Okaly:first tackle that first word I use stretched. What does
Joseph Okaly:stretched mean? It means that you would only be required to
Joseph Okaly:take a small portion every year out of the account. This
Joseph Okaly:required amount referred to as an RMD, or required minimum
Joseph Okaly:distribution was based on your life expectancy. As a child of a
Joseph Okaly:parent, you were younger, which made these distributions pretty
Joseph Okaly:minimal in most cases. Having very minimal required
Joseph Okaly:distributions is a good thing. Because the amount that is
Joseph Okaly:distributed is fully taxable as ordinary income. Less
Joseph Okaly:distributions means less tax. Now, the rules require you to
Joseph Okaly:take out all of these funds within 10 years. So your initial
Joseph Okaly:thought might be like, 'Hey Joe, you know, 10 years isn't so bad.
Joseph Okaly:Why is that really such a big deal compared to the old rules?'
Joseph Okaly:If you took the funds equally over 10 years, that would mean
Joseph Okaly:that every year you're taking 1/10th of the account, so 1/10th
Joseph Okaly:distribution per year. Under the old rules, a 50 year old would
Joseph Okaly:only need to be taking out around 1/34th per year, so a lot
Joseph Okaly:less. The other big point is that if you inherited at 50,
Joseph Okaly:you're probably still working at 60 for this new 10 year window.
Joseph Okaly:So now all this income is going to be realized most likely
Joseph Okaly:during your highest income earning years while you're still
Joseph Okaly:employed. This means that distributions are going to hit
Joseph Okaly:you in the top income tax brackets wherever you may fall,
Joseph Okaly:or push you into even higher ones. If you are of the mindset
Joseph Okaly:that tax rates are going to go up over time, by the time this
Joseph Okaly:happens to you, the top income brackets could be even higher
Joseph Okaly:today than today as well. The last part of this puzzle is not
Joseph Okaly:to forget that the assets are growing in your parent's
Joseph Okaly:accounts in the meantime. So whatever the tax liability might
Joseph Okaly:be today that's going to hit you, it's growing and growing
Joseph Okaly:and compounding as time goes on. A $200,000 IRA inheritance today
Joseph Okaly:might be worth $400,000 10 years from now, when your parents may,
Joseph Okaly:let's say pass away, all fully taxable as ordinary income to
Joseph Okaly:you needing to be taken out over a 10 year period of time. So
Joseph Okaly:what can you do? There honestly aren't a ton of options for you,
Joseph Okaly:but the main possibility is off of the last part of the puzzle I
Joseph Okaly:just mentioned. How or more precisely where your parents are
Joseph Okaly:going to be leaving these assets to grow. Let's say your parents
Joseph Okaly:had that $200,000 IRA, like we just had in the previous
Joseph Okaly:example. That means that maybe 20% of it, or 40,000, is owed to
Joseph Okaly:Uncle Sam. And that's just kind of a way to keep the math a
Joseph Okaly:little bit simple. If in 10 years, that account grows again,
Joseph Okaly:like we just talked about before to 400,000, that tax liability
Joseph Okaly:number now also doubles to 80,000, using that same 20%
Joseph Okaly:rate. And again, that's assuming tax rates do not go up in the
Joseph Okaly:future. And like we've kind of alluding to before, if you
Joseph Okaly:inherit it, during the height of your working years, 10 years
Joseph Okaly:down the road, it would be on your tax bracket. So maybe,
Joseph Okaly:let's say that could now be even higher, maybe as high as 30% and
Joseph Okaly:we're jumping all the way up to $120,000 now in taxes that's
Joseph Okaly:going to be due on this IRA. So 40,000, today might translate to
Joseph Okaly:$120,000 in taxes due 10 years from now. And as we're all
Joseph Okaly:wanting our parents to live nice, long lives, this might not
Joseph Okaly:be 10 years, it might be 20 years, 25 years. So you could
Joseph Okaly:see how this really could build up and be a very, very large tax
Joseph Okaly:liability down the road that you might be having to pay at some
Joseph Okaly:point. This growth, remember is happening regardless. But what
Joseph Okaly:if we can kind of change where it is growing? If your parents
Joseph Okaly:do small, what are called Roth conversions every year so moving
Joseph Okaly:part from this traditional IRA, into a Roth IRA, the Roth IRA is
Joseph Okaly:going to grow tax free. The amount of the conversion, let's
Joseph Okaly:say they converted 5000, that 5000 that's converted would be
Joseph Okaly:taxed today and your parents would have to be paying that tax
Joseph Okaly:today. If they're able to pay the tax on that now, in their
Joseph Okaly:maybe lower retirement brackets potentially and in addition to
Joseph Okaly:that, now all the growth is going to be tax free. So again,
Joseph Okaly:it is going to grow regardless, so a case can certainly be made
Joseph Okaly:for paying the tax today, so that future growth can be tax
Joseph Okaly:free. So let's just say as another example, just to further
Joseph Okaly:illustrate that point, we had the $200,000 IRA. If we looked
Joseph Okaly:at it right now with a 20% tax bracket, that would be $40,000
Joseph Okaly:in tax. Let's say that all of that was converted today that
Joseph Okaly:$40,000 was paid not recommending that, but just
Joseph Okaly:again, keeping the math simple. Now when that $200,000 account
Joseph Okaly:reaches $400,000, in 10 years from now, all of that now is
Joseph Okaly:going to be tax free to you. So that's a really, really, really
Joseph Okaly:big difference. Inherited Roth IRAs still have to be
Joseph Okaly:distributed fully in 10 years as per the new rules. However, you
Joseph Okaly:can just wait until year 10 build up as much tax free growth
Joseph Okaly:as possible, and cash out without any tax implications
Joseph Okaly:whatsoever. Whether or not this is a good fit for someone
Joseph Okaly:absolutely requires some additional planning though; what
Joseph Okaly:investments they may need or not, what funds they may have on
Joseph Okaly:the side to help in paying the tax, or even if minimizing taxes
Joseph Okaly:paid to Uncle Sam for their children is even a goal. Maybe
Joseph Okaly:this is just too much of a hassle for them and they could
Joseph Okaly:be of the mindset of whatever they get when I'm not here is
Joseph Okaly:what they get. And honestly, that's fair too. For those that
Joseph Okaly:do have it as a goal though, it can really be a well worth
Joseph Okaly:discussion, potentially saving 10s of 1000s of dollars in taxes
Joseph Okaly:paid over the long term.
Joseph Okaly:So the recap for today is realize that inherited IRAs or
Joseph Okaly:retirement accounts have unique rules if and when you inherit
Joseph Okaly:them. However, your parents do still have some powerful options
Joseph Okaly:in minimizing that tax potentially. Ask your parents
Joseph Okaly:'Did you hear about how they significantly changed the rules
Joseph Okaly:for for people inheriting IRAs? Do you know if your plan is set
Joseph Okaly:up to properly try and help minimize or reduce these total
Joseph Okaly:taxes being paid long term, mom or dad?'
Joseph Okaly:Thanks very much for tuning in today. As always, if you're able
Joseph Okaly:to implement what we're covering, then that's always
Joseph Okaly:fantastic. You have less to worry about than before and you
Joseph Okaly:can focus more on enjoying life today. If you are wanting help
Joseph Okaly:with these things though or have questions you need help and
Joseph Okaly:clarifying check out the Ask Joe section on the show's website
Joseph Okaly:www.enjoymore30s.com that's enjoy more three zero s.com. If
Joseph Okaly:you enjoy this specific episode, please make sure to subscribe
Joseph Okaly:and review us on Apple podcasts or wherever you listen. There
Joseph Okaly:are literally millions of young American families out there I'm
Joseph Okaly:trying to reach and help just like you. The next episode is
Joseph Okaly:the last in this Your Parent's Money Mindset series, titled
Joseph Okaly:Retiree Healthcare for Parents, A Lot Is Not Covered, where
Joseph Okaly:we're going to share some basics on Medicare, Medicaid, and
Joseph Okaly:probably most importantly, what they don't cover when it comes
Joseph Okaly:to long term care. Until next week. Thanks for joining me
Joseph Okaly:today and I look forward to connecting with you again soon.
Voiceover Audio:The conversations on this show are
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Voiceover Audio:any content or information found here first. Joe is affiliated
Voiceover Audio:with New Horizons Wealth Management, LLC, a branch office
Voiceover Audio:of TFS Securities Inc. and TFS Advisory Services an SEC
Voiceover Audio:registered investment advisor member FINRA/SIPC.