More and more Americans will inherit the wealth of their parents in retirement plans. The rules around inherited retirement plans have changed and getting them wrong can cause steep tax penalties.
Full episode Transcript:
Speaker 1 (00:02):
Welcome back to 30 Minute Money, the podcast that delivers action-oriented smart money ideas and little bitesize pieces. I'm Scott Fitzgerald at Rock Fox Recording and production in luxurious Bushnell's Basin and, uh, the best dressed financial advisor in the world, . Steve, where was I laying? I'm still not a little thin. I'm
Speaker 2 (00:23):
Still hung up on luxurious bush noses Basin.
Speaker 1 (00:27):
, come on, you come here once and I
Speaker 2 (00:29):
Love push Noses Basin
Speaker 1 (00:30):
Speaker 2 (00:32):
We're doing, there's no basin. I would rather be in .
Speaker 1 (00:34):
Right, exactly. So, uh, so we're, we're gonna talk about, uh, inherited IRAs today. We
Speaker 2 (00:41):
Are, yes. Because, um, there is a huge transfer of wealth going on, um, as the baby boomers retire, and then they're gonna leave their assets to the next generation or even, you know, the, the, the, uh, greatest generation leaving money to the baby boomers, a lot more and more and more of that is gonna be in retirement plant. Hmm. Um, you know, people are, are accumulating more and more of their wealth into retirement plants. When people come to me and talk about, you know, getting ready to, to make that retirement transition, what I find is that people typically have 75 to 90% of their wealth in retirement plans. Now, of course, a lot of what we try to do is shovel that money as fast as we can from those deferred accounts to the tax-free accounts. But when they come to us, they've got a very large majority of their money in retirement plans. And so more and more as people pass away, they're gonna be leaving those retirement plan assets to their beneficiaries, to their families, to their heirs. And there are some special rules that you need to know about inheriting an ira. They're different from the IRAs that you put money into from your paycheck or as you move along. And so I wanted to talk a little bit about what that is because, you know, if you miss one of those rules, you can end up paying, you know, lots of taxes that you don't need to pay.
Speaker 1 (01:57):
And are these the kind of rules that they're like, shh, don't tell 'em about this because then they'll have to pay all this tax.
Speaker 2 (02:02):
It's, well, it's uh, it's like all things tax. It's very complicated and very boring. So, you know, we fair enough, fair. You know, it's, you're not gonna see these on the front page of the, of the paper, you know? Gotcha. You're not gonna see it in People Magazine. So, um, so we, we want it's, but it's an important thing. And, and as an example, you know, I, I, um, I just spoke with a client, I just spoke with somebody just, uh, last week and she had inherited an IRA from her father and we, you know, and, and she had taken some money out right at the beginning and then she didn't take any money out for a couple of years. Well, you know, we'll talk about what some of the rules are, but she now has to pay a penalty because we, she wasn't paying close enough attention to the rules and, and wasn't keeping in touch with her financial advisor. And so now that I have a chance to talk with her, we said, okay, well let's catch up on this and let's get on that schedule so you can end up losing a fair amount of that money if you don't pay close to what the rules are.
Speaker 1 (03:00):
So I I, I might be jumping the gun here, but, so when you inherit an ira, there are obviously, you're saying there's different rules than if you were, if it was your IRA from your right. Um, can, can you just jump into that or do you have to? Cuz it's cuz the person's already I
Speaker 2 (03:20):
I don't know what you mean by jumping into it. So,
Speaker 1 (03:22):
Well, I mean you can start withdrawing from that IRA right away if it was, if you inherited Yeah, yeah. You don't have to have to wait anymore.
Speaker 2 (03:28):
No, you, well you never did have to wait, uh, for somebody, if you're inherited any inheriting somebody else's r i a, you never had to wait for it. Oh, okay. Um, and there's not a penalty to pull money out. Um, you basically have two choices. You can either take it all as cash, in which case it's taxable right now. Or it used to be that you could just inherit the IRA and very slowly take it out over the course of your life. But in 2019 when the Congress passed the secure act, they changed that. So we can't do that anymore. Now they're on much shorter schedules and so we need to be more sensitive to how fast you have to take that out. Now if you did inherit an IRA before 2019, or if the person passed away before 2019, you can take it out a lot more slowly. You, you can take it out for example, you know, potentially over the rest of your life. So that would be great cuz you can really stretch that out.
Speaker 1 (04:20):
Now, I'm not trying to, uh, get you to understand why they do anything when it comes to these tax laws, but what was the, what was the logic behind that about not letting people now let it drag on or, you know, take it out over time? Yeah. What, what's the reason for that?
Speaker 2 (04:38):
The government has starved for money. The government wants fair enough, wants to raise money as fast as they can. I mean, that's why taxes are gonna be going up in the future, right? Is we've got a seven, we've got a 31 trillion federal debt and we're government securities. Were paying a percent and a half a year ago. They're paying 4% now. So not only is it the most money we've ever owed as a country, but as three times as expensive as it used to be. So they're looking for cash any place they can find it. And, and by saying, we're not gonna let you take this out over 40 years, we're gonna make you take it out over 10 means they can raise some more money from that. Right.
Speaker 2 (05:15):
That's, that's not hard logic to figure out. Nope. . So basically if some, if some, if, if somebody leaves you an ira, you've got two choices, you can take it as cash or you can take it as an inherited ira and that lets you spread that tax burden over, over the course of a few years. There is an exception to that. The big exception of course, the one that's the most common is that somebody passes away and leaves the IRA to a spouse. A spouse can just roll those proceeds right into their own R i a. They're, you don't have to take, you don't, you don't get an inherited ira, you just put it into your own r i but only spouses can do that. Everybody else has to live with the inherited IRA rules. Okay. And so they have to start taking it out a little bit quicker.
Speaker 2 (05:56):
Um, typically the the, you have to spread the distributions out over the course of about five to 10 years. There are some exceptions to that. If, if you are disabled, if you are in, if you're terminally ill, if you're, you know, there are a couple of of situations where you can stretch it over a longer period of time than that. But for the most part, the rule of thumb is you have to take it out somewhere between five and 10 years. Um, and so you, the, the question is how do you, how do you spread that? You know, what, what rate do you take that out? Um, you can take it out as fast or as slowly as you want to, as long as it, the sl the slowest you take it out is equally over the course of 10 years. But one of the nice things about doing that is you don't have that, um, penalty before 59 and a half.
Speaker 2 (06:46):
That's one of the things I think you were referring to before. Yeah. If you have your own r a and you pull money out before 59 and a half, unless you AP apply some very special rules to it, you're gonna pay income tax on it and you're gonna pay a 10% penalty. Excise tax, but inherited IRAs, that's not the case. You can take money out anytime from an inherited ira. There's never an early distribution penalty. So that's good news. And um, you can't add money to an inherited IRA when you get an I inherited ira that's as big as it's, that's as much money as is ever going to go into it. You can't add to it after that. You can only take out
Speaker 1 (07:27):
Now, um, for the kids in the back of the row here, back of the class, the IRA is the one where you're taxed, uh, out after when you take it out. Right? Not okay.
Speaker 2 (07:39):
That's right. Yes,
Speaker 1 (07:40):
Because the 401K is the one where they tax it or it's it's pre-tax, right?
Speaker 2 (07:44):
Or that's well so 401ks and tradition, well 401ks, the money goes in before you're taxed on it. Typically. We talked a little bit about Roth, we'll talk about Roth again, if you take a Roth option ass different,
Speaker 1 (07:56):
I forgot that there's the Roth part
Speaker 2 (07:57):
Of that. Yeah. Now that I was different flavors of everything, you know, because the government wants to be Baskin Robbins and when it comes to, you know, retirement plans, they want 31 things to choose from .
Speaker 1 (08:05):
So we have 31 flavors and it's all dung .
Speaker 2 (08:11):
So it's like Bernie butts every flavor beans, you never know what you're gonna get.
Speaker 1 (08:17):
Speaker 2 (08:19):
Um, with uh, but standard, normal kind of typical thing, 401k, it all goes in pre-tax. A traditional ira, most of the time people do them because they take them off their taxes. So it's effectively pre-tax money you can do after tax IRA contributions, different kind of story. But the traditional IRA you can put money in and under the right circumstances it's tax deductible. So essentially it's pre-tax and then you pay the tax on it. When you take it out,
Speaker 1 (08:48):
Speaker 2 (08:49):
Roth Roth ira you you're putting in after tax money and you don't have to pay tax later on
Speaker 1 (08:55):
Because you've already been taxed
Speaker 2 (08:56):
Because, well, because you've already been taxed and the deal with the Roth IRA is even the earnings and profits don't get taxed later as long as you follow the rules, which are not that hard. Does
Speaker 1 (09:06):
Roth R o t h stand for something?
Speaker 2 (09:08):
Eugene Roth? It's the guy who who designed it? Yeah, it's the congressperson who came up with the idea.
Speaker 1 (09:12):
Speaker 2 (09:13):
Straightforward. The bill was named after him. So they, they they named the retirement plan after him. So he lives on Yes. Okay. Just like Roth IRAs, they can live forever. . Um, so inherited IRAs, you have to know how fast you have to take it out. Those are required minimum distributions. Um, the longest is generally going to be 10 years unless you're a spouse, they could be quicker. Um, and it depends on, um, whether the person who left it to you was beyond their re required minimum distribution start date. Um, so you might have to take it out a little bit quicker than 10 years. Um, and if it's, and if it's if, if if, you know, certain kinds of entities have to take it out in less than five years. Like if you leave it to a trust, it has to come out over five years. But if you are a, a natural person and you were named as a beneficiary on somebody's account, pretty good chance you can take it out over the course of 10 years. You can never add money to it when you take it out. You don't have an under 59 and a half penalty. Uh, but you do need to make those required minimum distributions every year. Because I dunno if you remember this from previous conversations, the tax on an, the penalty tax on an RMD that you did not take,
Speaker 1 (10:30):
It's like 50%.
Speaker 2 (10:31):
It's 50%. Hey, look at that. Ding, ding ding. Give a, give a gold scout to the guy across the table. . Yeah. So, so it, it really is.
Speaker 1 (10:40):
So is that what happens to the person you were talking
Speaker 2 (10:42):
About? That's happened to the person that I was talking to? Yeah. Is that, that she missed it for a couple of years and so we're gonna, you know, she's gonna have to file amended returns and she's gonna have to pay f 50% of what she should have taken ugh, as a penalty tax as well as recognizing it as income. So you really, really, if you inherit an ir, inherit an ira, you really wanna make sure that you're paying attention to how much you have to pull out every year because the price is really high.
Speaker 1 (11:08):
So a hypothetical situation. Hypothetical situation, um, somebody has their ira but they're not taking enough out of it like they should be. Yep. Then they pass away and they leave that IRA to somebody else. Does that person the beneficiary have to then pay the fees that they, uh, missed out on? Or, or, you know, because they didn't do it properly? Does that get transferred to the beneficiary? Is that something you have to look up? I,
Speaker 2 (11:35):
I can't, I cannot answer that off the top of my head. This is, this is like, you know, George Carlin did the thing. I I went to Catholic school for 13 years and it's kinda like, you know, the priest comes in on Friday for, you know, stumped the priest day. And it's like, well father, you know, if it's, if this is happening, but that's happening, this is that a sin then father? Right? It's, it's kinda like one of those, I would have to look that one up. I don't know offhand.
Speaker 1 (11:55):
That's fair. Took me a while to come up with the question anyway. So. All right. So inherited IRA's, 30 minute action list,
Speaker 2 (12:11):
30 minute action list. If you have inherited an ira, take a look at how much you took out last year and get some advice on how much you need to take out every year.
Speaker 1 (12:21):
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All right, well that's another episode of 30 Minute Money. Of course, you could find firstname.lastname@example.org and, uh, Steve email@example.com if you find firstname.lastname@example.org. Thanks for listening and watching. We'll catch you next time on 30 Minute Money.