[00:00:39] Andrew: All right. We are back for another episode of Your Wealth & Beyond and today is the third part of our three-part series on required minimum distributions. The initial Episode 1 was simply more of the basics, what is RMDs, why are they there, and how as an individual they should be incorporated into your plan both pre- and post-retirement. Episode 2, we had gotten a lot of great feedback on Episode 2, was five strategies to reduce or limit your required minimum distributions. So, those of you that did not listen to Episode 1 or 2, you can always find them back on the show notes on our podcast page and/or on iTunes, Google Play, Stitcher, etcetera.

So, today’s show our last show is about what to do when you inherit a retirement account whether it be a 401(k), an IRA, a Roth IRA, a SEP IRA, a simple, I could keep naming but you guys would fall asleep. Fine. There’s TSPs. There’s 457s. There’s 403(b)s. What else we got? But honestly, the key to inheriting IRAs and other qualified retirement accounts, the very first thing you have to do is understand that in most cases you’ll have options, especially for a spouse. So, today the show is going to center around three points. The first is that you’re a spouse, your husband or wife or partner passed away, what do you do? What are your options? Secondly, we’re going to talk about inheriting an IRA for a non-spouse and what are your options? And then thirdly we’re going to go through some of the costly mistakes that individuals make both a spouse as well as a non-spouse and ways in how we can eliminate that.

[00:02:41] Andrew: Because if you mess up, there is and there hasn’t been, going back to the IRS saying, “Hey, I messed up or my advisor messed up or my CPA messed up.” Inevitably, if you mess up, it could cost you tens if not hundreds of thousands of dollars. So, our job here on this show and our job when we’re working with clients is to help make sure that they don’t screw up. And so today very, very beneficial, you’ll have an opportunity to ask us questions. There’ll be a couple of items in the show notes that you’ll be able to download and as always, let us know. You have questions, concerns, if you want to talk to an advisor, you can reach out at us always at questions@bayntree.com. So, let’s go through the first area. You are married. Your husband or wife passes away. What are my options? So, one of the key parameters here being a spouse is that you’ve got a lot of options, a plethora of options.

The first and usually the one used in the majority of times is that you can roll that retirement account into your own IRA so that is option number one. You can treat that IRA and let’s say that account is held at TD Ameritrade and your husband passes away. The one simple option is with death certificate. As long as you are the primary beneficiary, you as the surviving spouse can turn that account into your IRA. Very important there and a lot different than if you are a non-spouse or an ex-wife or ex-husband or family member, etcetera, which we’ll go through the second part of today’s show. So, what would happen is now this IRA becomes yours. You can invest it in any way that you want.

[00:04:37] Andrew: Remember, an IRA or a Roth IRA is just simply a vehicle that holds an asset and has a tax qualification. It means you can invest it in stocks and mutual funds and bonds and annuities, cash, money market, CDs. So, a lot of times we’ll have clients come to us and say, “Well, I’m going to open up a Roth. What’s the Roth going to make me?” Well, it inevitably means what do you have invested in? And that’s again asset allocation and your plan and risk tolerance. That’s a whole another episode that we can go through. Now, it’s never as simple as just rolling it over. There’s a couple of things we have to look at with the spouse. First off, if your deceased spouse was over the age of 70 ½, first and foremost, before you can rename that account into your name, we have to make sure the required minimum distribution if that individual was required to take out their required minimum distribution and they had not done that before they passed away, we have to make sure that the custodian who’s handling that account takes out the minimum distribution based on their life expectancy.

So, in a sense, before money moves out, we have to pretend that that individual in a sense is still alive and take out the minimum distribution and pay the taxes on it. Once that occurs then that account can be rolled over or renamed into the spouse’s name which now becomes theirs. If the deceased spouse was under 70 ½, there are no required minimum distributions and if they were over 70 ½ and taken out their RMD that year and then passed away, there’s no required minimum distributions.

[00:06:26] Andrew: Now here’s another key component. If the spouse that inherited that IRA is under 59 ½ if they rename it and make it their IRA, one area of potential concern is that now because that’s their IRA, they fall under the restriction, the 59 ½ rule, which means that any withdrawals that were taken out prior to 59 ½ would be penalized at 10%, plus, it would be taxed. So, here is a little strategy that many advisors and CPAs do not let on. Maybe they don’t know or what have you but we at Bayntree we know these things and I’ll give you an example. A client years ago his wife passed away and he was only 51. She had a 401(k) and his thought process was, “Well, I’ll go and I’ll turn this into my IRA account.” If he did that with him being 51, he would’ve done that. There’s no taxable consequence. It would’ve continued to grow tax-deferred but the issue would’ve been that he would not have been able to get to that money without penalty of 10% and taxes.

This individual didn’t know if he would need the money or not. So, we created an inherited IRA. So, listeners, a spouse can treat it as their own. They can also make it an inherited IRA. The benefit here and there’s two parameters to this. The benefit is that they can start withdrawing money with no 10% penalty even though they’re under 59 ½. Why? Because it’s an inherited IRA. Now, anything they pull from it, taxable as ordinary income. Now, the second stipulation though just like an inherited IRA to a non-spouse which we’ll get into a little bit later, now that individual even though they were married and that was the spouse is an inherited IRA now which means they have to start taking out the minimum distribution based upon the inherited RMD expectancy table.

[00:08:44] Andrew: And that’s something that the table itself you have to look at your age and the year that that individual passed. There’s a life expectancy meaning for me as a 41-year-old if I had to take out money right now if I inherited a money, it would be about 2.3% withdrawal rate. What happens is every year the amount that is required for me to pull out goes up because of the parameter that the government, the IRS, they don’t want you just deferring money that was received from an inheritance because everybody would just keep deferring money for as long as possible and that would not be a very good thing for the government although it would be a very good thing for us. So, in this example, this 51-year-old now has a required minimum distribution until they attain the age of 59 ½ and then here’s the beauty of receiving money from a spouse, flexibility, and options.

Once he turns 59 ½, we can then change that account from an inherited IRA to a regular IRA. Why would we do that? Why would we do that you ask? Well, the reason being is that now with it being his IRA, he does not have to take out the required minimum distributions until he turns 70 ½. So, you see what we did there? Spouse passed away. Surviving spouse was under 59 ½ and wanted the ability to access to those funds with no penalty so we created the inherited IRA and then at 59 ½ we turn it over and make it a regular IRA account. Pretty neat, huh? So, that’s something that a lot of individuals don’t know especially if you pass, you have a spouse passed away and you’re still young. So, that is options one or two depending upon the situation there.

[00:10:37] Andrew: Now, some plans if it was a 401(k) they may allow you to continue keeping it in the plan for a period of time. One of the areas though is that a lot of times it makes more sense to transfer that out to your own IRA or your own inherited IRA because you’re not under the mercy of the 401(k) plan rules. By all means, that’s something that you’d want to look at to see what those plan rules are, what the investment options are, but a lot of times again moving it to a regular IRA on an inherited IRA allows you to take more control of how you invest it. Another option for a spouse and this one usually doesn’t make sense but it’s an option is that they can withdraw all of the money and take a distribution. So, what that would do is cause major pain on taxes.

Let’s say it was $0.5 million account and they took the money out and they didn’t roll into an IRA or an inherited IRA, boom, that 500,000 is going to be taxable as ordinary income in the year it was received. On top of that, any other income from work, from passive income, from investments, from pensions, all of that would be combined together. So, what’s happening there is you’re putting yourself up to the highest tax bracket. You’re going to get taxed on the Fed. You’re going to get taxed on potentially the state if you live in a state that has income taxes. Potentially capital gains could go from 15% up to over 20%. So, many factors here. There’s phase-out and deductions. So, clearly, if you think you may need that money, it usually makes sense to transfer that over to an IRA in your name, again, we’re talking spouse, moving that into an IRA even if you just keep it in cash, and then use the money as you seem or need it and that way you’re controlling your tax destiny.

[00:12:37] Andrew: So, a spouse, the key component here has a lot of options, a lot of flexibility but you don’t want to mess up. You want to make sure you’re working with a good advisory team that’s leading you, understanding how it’s going to fit in with taxes and giving you all of the options that are available. So, spousal benefits, lots of options. Now let’s talk about a non-spouse. A non-spouse is somebody who’s a beneficiary, receive it from mom and dad. Mom or dad passes away. You’ve got a niece. You’ve got a sister, an ex-spouse. So, basically, it’s anybody who’s receiving this money that is a non-spouse. So, a couple of options. Number one, there is flexibility. There are going to be options just not as flexible as the spousal IRA. Also, if you make a mistake with an inherited IRA, there’s really no room for mistake.

So, let’s go through some options and I say there’s no room for mistake because we’ve seen the IRS come back and not give forgiveness because when we receive an IRA if we take it out as a distribution so will option number one which is probably the worst option is that the individual, the beneficiary let’s say dad passed away and two children 50% each are the primary beneficiaries. Child A maybe isn’t too bright or doesn’t have guidance. Yeah. We don’t want to take anything to account but let’s just say they take out their 250,000. Again, boom, taxable as ordinary income in the year that they received it. All their other income will also be taxable that they received so they’re jumping up to probably the highest tax bracket or close to it. So, option one, take out a distribution. Option two is that they could leave their share there and take it out over a five-year period.

[00:14:44] Andrew: So, again, that gives you the ability to not do anything with it but take it out over a five-year window and that means that you don’t necessarily have to take it all out at once. You could take it out systematically but at the end of that five years, it has to be completely taken out of the tax-deferred vehicle. So, although that helps to spread out the taxes, it really doesn’t do much justification to the power of deferring this IRA, the power of ensuring that that money that was passed down to you will leave a legacy for you in the maximum amount and also to potentially go down to your family. So, option one, take it all out. Option two, leave it in the plan and take it out over a five-year period, has to be all out by the end of that fifth year.

Option three, make it an inherited IRA. Option three is usually the best option. Why? Because it gives you the most flexibility. So, dad passes away, 250,000, primary beneficiary one child, 250,000 the second child. Each of them has the option to do what they want if they’re listed as the beneficiaries specifically. So, let’s say both of these individuals, brother and sister, are smart, they’re diligent, they got a good advisory firm, and they want to set up an inherited IRA. So, what happens is that they have to roll over that money. It has to first, though, the account has to be separated out and qualified and renamed as an inherited or a deceased beneficiary IRA. By doing that, now the individual, the new owner of that account has the ability to roll it outside of that custodian.

[00:16:39] Andrew: But first and foremost, you want to have the current existing custodian separated out and retitle it. Once that happens, you can keep it there or transfer it to an inherited IRA at a different custodian. But by doing this, you are not going to be liable for the taxes in that year. So, what happens to this account is it starts growing and continues to grow tax-deferred and compounds just like if you had a regular 401(k) or a regular IRA. Now be careful. You cannot move an inherited IRA to your own IRA. Let me repeat that. You cannot take an inherited IRA and move it to your own IRA. If you did that, it would be like you taking a distribution and you would have to pay the taxes on it so you got to keep it separated.

Secondly, you have to start pulling out required minimum distributions based upon the single life expectancy table. Now, there are some areas where you have to do it based on the older or the oldest beneficiary and that’s listed if a trust is on there or if there is no listed beneficiary then it reverts back to the oldest but let’s assume mom and dad or whoever was the owner of the account did everything correctly. So, think of the power here. Now, this individual who inherited 250,000 from dad can continue to grow that money tax-deferred. Each year they’re going to have to take out a percentage. That percentage goes up each year. They have to take that amount out to satisfy the required minimum distribution. They will pay the tax on that money but the remainder of the dollars inside of that account will grow tax-deferred so think about and you can run the Excel spreadsheets if you want. We’ve got great software to show you.

[00:18:35] Andrew: But think about if you made 5% a year and you’re taking out 2%. Yes, every year that withdrawal rate goes up but think about the power of compounding. There’s never any 10% penalty when you inherit an IRA which means that you as the recipient of that money controls your own tax destiny. And I’ll give you an example. A couple of years ago another client passed away and was leaving about 600,000 to his two children. One of them wanted and needed the money to buy a house and this was around the late fall timeframe that this all happened. So, rather than taking out all 300,000 in one tax year, what we did is we set up the inherited IRA. We took out a portion of the funds for that year meaning 150,000. We then waited until January of the following year and took out the remaining 150,000.

So, although it wasn’t ideal for them to take all that money out, it was something that they needed but by doing it that way, we were able to spread out the taxable consequence. Now, if it were up to us, we would have helped try to push them to do it a little bit longer over a three or four-year window and a lot of times we’re able to show why that makes more sense spreading out the taxes but that’s either here or there. The key component is rather than taking that 300,000 out in one year, it was spread out. They controlled their tax destiny and the other is you never know, the following year they may not need all of that money. So, key component here, one of the best options is to change or transfer the account to an inherited IRA and ensure that that money continues to grow. Now, if and we’ll talk about some of the mistakes that we make but if you don’t do it correctly, the IRS will not get you a retribution. We have not seen them come in and provide leniency like they have in other areas.

[00:20:42] Andrew: So, that same 300,000, that could be a mistake that costs 100+ thousand dollars. So, we always say whether you’re a spouse or a non-spouse, the first thing you should do is nothing. You’ve got time especially a non-spouse and you want to make sure all the ducks are in a row and you understand your options and the complexities and you get the right advice so that you can make the best decision possible. So, overall, if you make some bad mistakes there, it’s very tough to go back and change that. So, very, very important. Now let’s talk about Roth IRAs. So, one of the benefits of a Roth IRA, when we’re alive, is that there are no required minimum distributions. So, to recap on a Roth, the money goes in, you don’t get a tax deduction. The money grows tax-deferred. When and if you pull money out, it’s tax-free. There are no required minimum distributions. So, a very powerful asset, a very powerful type of account.

When an individual passes away and let’s say the Roth IRA was going to one child, that child has options, the same parameters as what we discussed with the IRA. They can take it all out in a distribution. The main difference here though is if they take out that $500,000 Roth, there is no taxable consequence. So, a Roth is a great legacy play because there are no taxes both on the Fed or the state. So, that 500,000 goes down to this child but now it’s after-tax money so they didn’t pay the taxes on it but now they have to put something in, in regards to whether it be investments that are in stocks or bonds, mutual funds, what have you, but now they’re going to have to start paying the taxes on that money.

[00:22:45] Andrew: Not the end of the world but what if they could inherit that Roth and continue what’s called an inherited Roth IRA. Well, guess what? They can and think of the power of growing deferring the money and the growth inside for all these years. So, here’s how an inherited Roth works as it’s basically the same premise. You have the account retitled to an inherited Roth IRA. Here’s the one caveat though. In an inherited Roth IRA, it is mandatory to take out required minimum distributions very similar to the inherited IRA based on your life expectancy. So, you might ask, “Well, why do I have to take out money from an inherited Roth if I don’t have to pay taxes on it?” Well, that is accurate and that’s a good question.

So, each year you have to take out the minimum amount. You don’t pay taxes on it. What the government is looking at here is basically saying, “We’re going to give you the ability to continue growing this Roth tax-deferred and you’re going to get to take out the money tax-free at any time but we don’t want you to keep it in there forever so every year you’re going to have to take it out and do something with it.” Even with that being said, it’s still a tremendous value to create an inherited Roth IRA to grow it however is fit for your plan to have control of that money when you need it and allow the rest of that money that you do not have to take out based on the required minimum distribution, the rest of it growing tax-deferred, and then at some point that will be tax-free when you pull it out or if you pass away. So, that is a powerful entity and more and more of us have Roth IRA accounts so that’s the beauty of the Roth.

[00:24:37] Andrew: That’s why when you are here with us and we’re talking about Roth conversions, it’s one of the true values of taking money from an IRA moving it to our Roth and that can provide one or two generation of wonderful growth and of course tax-free is always the best way. So, inherited Roth IRA a little bit different than an inherited IRA but it still gives the options for you. Back to the original spousal option. We didn’t touch on it but they would be able to do the same component of the regular. They’d be able to transfer the Roth IRA into their name and continue to grow that money tax-deferred. There would be though no required minimum distributions. Very important stuff there. So, we’ve got spousal, a lot of options, a non-spouse, still quite a few options, and options are the key.

So, lastly, before we end today, let’s touch on some of the costly mistakes that are out there and we’ve talked a little bit about these as we’ve gone through what those potential options are for each of us inheriting a retirement account. But first and foremost, a non-spouse cannot do an indirect rollover. That means normally with a spousal rollover, there’s something that allows for a 60-day indirect rollover. That means if a spouse takes money from a retirement account or an IRA, they have 60 days to put it in their name. Well, an inherited IRA or a non-spouse doesn’t have that option. So, if they requested and the custodian sent the money to them from an IRA that they inherited from a non-spouse, a mother or father, a friend, niece, nephew, partner, that money would be taxable and we’ve seen it time and time again.

[00:26:37] Andrew: We’ve seen the individual go to the IRS even through private letter ruling and say, “Hey, I screwed up,” or, “Hey, my advisors screwed up.” The IRS said, “You know what, we’re sorry but you owe the taxes on that,” so that could cost you tens if not hundreds of thousands of dollars. So, very, very important. A second error that we see is an incorrect account titling. So, an inherited IRA must be set up with the proper account title. The deceased IRA owner’s name must appear in the account title and it should show that it’s an inherited or beneficiary IRA. So, we’ve seen institutions, custodians that are not using this account titling. Instead, they recorded it in their records as an inherited IRA but what happens here is that could cause confusion and normally we want to list the date of the death. Why is that important?

Because that date of death will always ensure that it’s known that it’s an inherited IRA and that also helps when trying to calculate what the required minimum distribution will be. So, very important that you ensure that you get maybe a second set of eyes on how the IRA that you’re inheriting how it’s titled. Third mistake that we see is that individuals who create an inherited IRA start contributing to that IRA. Well, that’s one of the key components here is this not your IRA. You cannot combine it with your own IRA. Your own IRA you have the ability to contribute to it as long as you have earned income. In an inherited IRA, you cannot add money to it. You can only take money out from it. So, if you do that, it cannot be corrected and the entire amount would have to be distributed.

[00:28:39] Andrew: That could be a huge, huge, huge mistake so do not contribute any money to an inherited IRA. Not a great idea. A horrible idea, one of the worst you could ever do. So, again make sure you’re getting really good advice. Number four, delaying the RMDs. So, the required minimum distributions on an inherited IRA or an inherited Roth IRA generally begin in the year after the IRA owner’s death. A common mistake is when non-spouse beneficiaries are told that they do not have to begin RMDs until they turn 70 ½. Remember, guys, the 70 ½ rule is only for IRA owner’s RMDs, not for inherited IRAs and we talked about the Roth inherited IRA. It’s the same premise. Now, the younger you are, the less you’ll have to pull out, to begin with. The older you are, the shorter your life expectancy, the more that you require that you pull out.

So, very, very important there. You have to take out mandatory distributions even from an inherited Roth IRA so make sure you understand what that is. Now, when that money comes out, you can do anything you want with it. You got to pay the taxes unless it’s a Roth but then you can reinvest it and you can hypothetically if that money comes out to you, you can then turn around and put it right back into your own traditional IRA or a Roth IRA or a 401(k) so you got a lot of options there and if it goes into an IRA, you can help zero-sum the taxes meaning the money comes out of the inherited. It will be taxable but if it goes right back into an IRA up to the limits 5,500 or over 50 at 6,500 it enables you to maybe eliminate some of the taxes on there.

[00:30:36] Andrew: And then a stretch IRA confusion, this is the fifth mistake that we see. Not every non-spouse beneficiary gets to stretch an IRA over their life expectancies. Only beneficiaries who are designated beneficiaries qualify for the stretch. A designated beneficiary is one who is named on the IRA beneficiary form or who inherits through a default provision in the IRA custodial agreement when no beneficiary is named. If the beneficiary inherits through an estate, he or she is not a designated beneficiary. In this case, the RMDs depend on when the IRA owner died. The IRA owner died before 70 ½ then the entire inherited IRA would have to be paid out by the fifth year after the death so that goes into that five-year rule. If the owner died on or after his required beginning date then the beneficiary takes RMDs based on the IRA owner’s remaining single life expectancy that he lived.

So, I went through a lot of verbiages there. The key is when you don’t name an individual beneficiary, you lose a lot of options. You lose the flexibility. So, one of the things that we do at Bayntree and we’re real big proponents of is an IRA or 401(k) beneficiary checkup. Many of you had set up your 401s or IRAs years ago and you put beneficiaries on them. You might have put mom or dad or a sister or brother and then you got married and you may have forgotten to put that spouse on or you got divorced and you may have forgotten to take your spouse off. The beneficiary form is critical. It trumps any estate planning and it ultimately also will have some extreme ramifications in regards to those that inherit an IRA so check those beneficiary forms.

[00:32:42] Andrew: You want to call the custodians. You want to ask to see the beneficiary forms. If your advisory firm is not doing that, then they’re not doing you justice. The beneficiary form although simple and a little bit of paperwork is one of the most important pieces of the assets that you’re accumulating in your retirement buckets.

So, today to summarize, we went through what is options are for a spouse. We went to options for a non-spouse and then some of the costly mistakes that are made. We did go through a lot of information so the beautiful part of our podcast at Your Wealth & Beyond is that there’s a transcript. There are show notes. There are link outs so that’s something that you can go back and if something you missed or might have rambled on too quickly there, you can go and read it. Also, we’re here for you. Part of it whether you’re a client or not, we look at being able to provide really good information.

We can help steer you in that direction so if you want to set up a 15, 20-minute call with our team here, you can do that. The way to do that is just email us at questions@bayntree.com or also on the podcast page is a pop-up that allows you to put your information in there. We’re really, really passionate about making sure that you don’t mess up. I keep going back to that but think about the money that your family had saved and put away and if you have the ability to continue that legacy and take advantage of some of these tax rules out there, the key premise is let’s do it. Let’s understand what the options are. Let’s not make rash decisions. Let’s make decisions based on facts and what’s right for you and inevitably it may make sense to pull it all out and pay all the taxes but you need to know what those ramifications will be.

[00:34:33] Andrew: So, I hope this three-part series was helpful for you. If you have any friends family, colleagues that could benefit from it just has it along to them. Also, if you have other questions that you have regarding your retirement, shoot us an email or if you want us to do a particular show on a subject, we to hear from you. Now, the 300 plus families that we work with here at Bayntree we know the type of questions that you’re already thinking, that you’re already asking, but it’s always great to hear from you guys to see what we can do to get good information out there. We love it. It’s some of why we spend the time doing the podcast, writing the books, getting out there. So, I hope this was helpful. If you need anything, we’re here for you at Bayntree. Our motto is you dream, we plan. The Your Wealth & Beyond podcast was built to help you empower yourself to build wealth, to find purpose. We’ll talk to you. Stay tuned for a new episode of Your Wealth & Beyond coming up soon. Have a great day and happy planning, everybody.

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Thank you for joining me for today’s episode of Your Wealth & Beyond. To get access to all the resources mentioned during today’s podcast, please visit Bayntree.com/Podcast, and be sure to tune in later this month for another episode of Your Wealth & Beyond.

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Investment advice is offered through Bayntree Wealth Advisors, LLC, a registered investment advisor. Insurance and annuity products are offered separately through Bayntree Planning Group, LLC. Bayntree is not permitted to offer and no statement made during the show shall constitute legal or tax advice. You should talk to a qualified professional before making any decisions about your personal situation.