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IRS Confusing Tax Policy That Could Affect Your Retirement or Future Generations

Mike Weber, CFP®

Mike Weber, CFP®

Investment Advisor Representative

May 28, 2021

The New 10-year-Rule for Inherited IRA Distributions

Intro:

Fairness and honesty…I think these are things that most of us want in our daily dealings. Then, enter the IRS; more of a political entity than a fair and honest public trust institution. After all, the IRS does stem from the Executive branch of the US Government. Do we really trust our elected officials as a society, I mean really, do we?

Maybe individually some do, but collectively, do we? I do not know the answer, so please do not look at me, we can all point our puzzled looks right back at each other (I think that’s definitively American politics…an indescribable look of confusion and wonderment).

What I do know is just as NON-finance/accounting-professional members of the public were starting to understand the IRS policy on Inherited (Beneficial, Stretch) IRAs and the term “Required Minimum Distribution” or RMD (for the intellectual types), the IRS changes the rules again. 

Fine, I have no issues with that, if that is what our elected officials feel is the best thing for our country.  But if you are making the rules, shouldn’t you know the details, the why, the potential impact in real life and understand how to communicate all this effectively to the public?  It is the IRS, so I will digress and finally begin my points.

Key Takeaways:

  • Old IRS Inherited IRA Rules – stretch out the taxes, make the money last for your retirement (think of a friendly Matthew McConaughey movie character voice).
  • New IRS Inherited IRA Rules – we want our money sooner; you now have 10-years to use the money and pay taxes. It is a shame life expectancy keeps going up, but the IRS wants their money! (think of a Darth Vader voice or any other voice from your worst nightmares).
  • Investing is a long-term endeavor; this IRS rule certainly puts a damper on your Inherited IRA investment strategy. I do not plan for any client’s money to last only 10 years or all be distributed within 10 years.
  • Retirement investment strategies are tricky in that way: you need the money to last a long-time, keep up with inflation and provide the cash flow a client needs/wants.
  • The more the IRS dips into the retirement funds of US citizens, the harder it will be for everyone.  At some point, if they dip their IRS sticky fingers in too much, the US will be a welfare state for all.

Did you recently inherit or are you about to inherit an IRA or Roth IRA? Want to skip my incessant run-on sentences and schedule a 20 Minute Consultation with me?  Click here for access to my calendar.

Old IRS Inherited IRA and RMD Rules for Non-spousal Beneficiaries:

  • Given the original IRA owner was deferring taxes and never paid Federal taxes on their Traditional IRA (401k,403b, etc.), the IRS allowed a NON-spouse beneficiary to transfer the decedent’s IRA into an “Inherited”, “Beneficial”, or “Stretch” IRA under the beneficiary’s control.
  • The owner of the newly formed Inherited IRA typically calculated the RMD based on their life-expectancy and at a minimum made that taxable withdrawal within the current tax year, then did the same thing every year until they pass away, or the money runs out.
  • This was often commonly referred to as a “Stretch” IRA, because it allowed the beneficiary to pay the taxes over time and not jump to many IRS tax brackets in the process.

THE IRS WANTS THEIR MONEY and will take it at their pleasure! (I think this should be a common saying like “Don’t Fight the FED” in financial circles.)

Well, I guess the old way was not getting the revenue the IRS wanted from hard-working, thrifty and diligent American families.  By the way, I thought the US had a retirement crisis?!?!? I thought the government was telling us that US citizens did not have enough saved for retirement and Social Security was not meant to be the only source of income people relied on?!?!? Oh well, the heck with that, when the cupboard is bare, the IRS will always come knocking.

New IRS Inherited IRA Rules for Non-spousal Beneficiaries (in a nutshell):

  • If you are NOT an “eligible designated beneficiary” or a minor child (effectively a spouse or child under age 18), then you are required by the IRS to take all the funds out of the Inherited IRA by December 31st of the 10th anniversary of the original owner’s date of death.
  • If you inherit an IRA with a $500,000 balance, as an example, you can: 1.) take it all out day one, pay IRS taxes at the highest rate and invest whatever is left over elsewhere, 2.) Break up the distributions over the 10 years, like $50,000/year plus interest/earnings and make sure it is all out of the account by the tenth anniversary or 3.) Let it continue to grow tax-deferred for 10 years and possibly double in value, gamble on what tax rates will be and take it all out in the tenth year. These are simplified examples of what you “could” do, and people are currently devising many other more complex ways to play the IRS “shell” game.
  • If you do not follow the IRS rules, there are severe penalties for being caught. So, do not get caught…I mean play fair and pay your fair share…whatever that is?? Seriously, there is a difference between tax avoidance and tax evasion. One is perfectly legal and the other definitely is not.
  • If you are a spouse inheriting an IRA from your spouse, you are allowed to transfer the IRA funds into your own IRA and avoid the 10-year rule.  If your beneficiary is a minor, then the real fun begins with IRS rules. If your beneficiary is an entity other than a real person, be very careful.
  • REMEMBER that RMDs, the 10-year rule and other IRS rules DO apply to Inherited Roth IRAs even if they DO NOT apply to the original owner’s Roth IRA.
  • If you really want to get confused and put yourself to sleep at night, click here for the IRS publication.

How does this impact your investment strategy if you inherit an IRA?

In the rocky landscape of my analytical mind, this change impacts people’s investment strategies for retirement greatly. However, it now impacts every individual and family differently. And therein lies the rub. Prior to 2020, someone, your mailman, your landscaper, your neighbor, could have told you that “the best thing to do is to open a stretch IRA, minimize taxes and invest the money for the long-term,” as they console you over the loss of a loved one.  They probably would have been right.

Now, what if you are planning, want to or need to work another 5-10 years to live the lifestyle you want in retirement?  Then, you lose someone that you cared about, and they cared about you.  They left you their hard-earned retirement savings, so you and your family could have security and hope in the future they knowingly will not be a part of. Do you choose option 1, 2, or 3? Are there any “good” options from a tax perspective? Maybe, but it is much more complicated now. That is just one of many scenarios likely to happen in real life.

After you choose your distribution option, how should you invest the money? If you must take the money out by 12/31/xxxx date, when do you eliminate volatile assets from the portfolio, like common stocks? What if six months prior to 12/31/xxxx date, you own a large percentage of stocks and there is a major unforeseen economic, geopolitical, health or other event that causes your well diversified portfolio value to get slashed?

Who knows, maybe the government will come to everyone’s rescue and tell everyone to not make the demanded IRS RMD distribution until the economy and market recovers. Then you can have the luxury of investing these funds with a nice interest rate and reasonable yields for risking your money…oh I forgot again, that did not happen the first several times the government stepped in to save us all. 

Is that the world we live in now? One with overly complex IRS tax rules that do not seem to really be in the “peoples” best interest, but the government will step in to save us all if needed. Maybe, and maybe it always has and always will be that way.

I believe you need effective financial planning at all stages of life.

Thanks to the IRS, I now have another reason to tell my clients and others that you should have a financial plan.  A financial plan that is living, flexible and changes when it needs to change.  Guess what? The planning only works if it is in-advance and it is only based on what we currently know. 

I hate to state the obvious but believe me it does come up often as modern life demands our attention every second; many people fail to think about what they want money to do for them in the future and what they might be willing to give up today to make it happen.

What do you want? How can your future financial independence help you be happy? Do you have a plan to get there that is dynamic and protects those you care most about?

If we go back to the rocky cliffs of my mind (I know this may be a scary place to some), personal investing, investing for human life-expectancies and family generations, and financial planning are synonymous. It all starts with you. What you want. What your vision of the future is.

It is my job to be your financial guide, understand you and figure out the financial puzzles to fit the vision of your personal future. It is my job to be getting bounced around by the IRS, the markets and know how to keep the ship on course like the Skipper in Gilligan’s Island…no, no, no…I mean like a worthy sea captain that doesn’t crash the boat and get everyone stranded like Captain Nemo in his super submarine, the Nautilus, helping out those in need. 

Investing is just one tool in the trusted financial advisor’s bag and, of course, it is an important one. But it is also important to consider how much you, or your family get to keep for your hard work.  Therefore, understanding tax, estate, risk management and economic strategies are very important to people’s lives and future generations.

Trust me folks, financial planning is far from easy, ever evolving and can be the best way for you to get the maximum value from a “Financial Advisor” at any stage of your life. You should get help from a trusted, fee-only, fiduciary advisor that will not sell you down the river like the IRS, always acts in your best interest and always has your back.

An “advisor” will never sell you a product. That is the job of a salesperson. I do not think there is anything wrong with either if the person has self-identified themselves appropriately. Unfortunately, the vast majority of “financial advisors” are Financial Salespeople and not “advisors” at all. 

I work with other trusted professionals in the areas of tax, estate, insurance and lending, etc.  Some of those professionals rely on selling a product to generate their revenue and there is nothing wrong with that business model, because they are not going to confuse you by telling you they are your advisor and then sell you a product. They will be transparent, fair and honest upfront.

I am a trusted advisor to my clients and will never sell you anything (especially down river!). Let us start the journey together!  Whether your retirement accumulation journey is just starting or you’re ready for the best journey of your life, your financially independent, non-working life. I am here to help you and create a lasting, long-term relationship together.  I am a fee-only, fiduciary, trusted advisor (really, I am an advisor, sorry it gets confusing out there).

You can schedule a 20 Minute Consultation on my calendar here.

Let me know how I can help you.  Contact me at:

Mike Weber, CFP®

Investment Advisor Representative

Blue Bell Private Wealth Management, LLC

mweber@bluebellpwm.com

484-221-5408

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IRS Confusing Tax Policy That Could Affect Your Retirement or Future Generations

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