Welcome to Something More with Chris Boyd. Chris Boyd is a certified financial planner, practitioner, and senior vice president and financial advisor at Wealth Enhancement Group, one of the nation's largest registered investment advisors. We call it Something More because we'd like to talk not only about those important dollar and cents issues, but also the quality of life issues that make the money matters matter.
Here he is, your fulfillment facilitator, your partner in prosperity, advising clients on Cape Cod and across the country. Here's your host, Jay Christopher Boyd. Welcome everybody. Thanks for being with us for another episode of Something More with Chris Boyd. I'm here with Jeff Perry. We're both of the AMR team at Wealth Enhancement and glad to have you with us.
Last week, you may have been listening and Jeff and Russ were handling the show and I was really enjoying the mailbag while I was away. Well, in any case, as you may have mentioned, I was doing some continuing education. One of the video clips they referenced in the program was by Warren Buffett saying, best investment is investing in yourself. That's what we're trying to do. We're trying to invest in the kind of education and information that helps us do what we do with our clients even better.
So I thought I'd try to share, you know, maybe there's all these various things we could talk about Jeff, but I thought maybe one of the tidbits that can get confusing since the Secure Act and thought we'd talk a little bit about what happens with different kinds of beneficiaries from an IRA and try to clarify some of those rules. And candidly, this can get confusing, so I'll try not to make it as clear as mud as they say.
Well, just the other day, you and I were talking about a client and he has a beneficiary IRA and the amount that he is taking, his inherited amount, seemed too small based upon what the current rules might be. But then we looked and he had like 10 years ago, he had started, he had received this beneficiary IRA, inherited IRA. So the rules were different then. So it depends on when you might inherit it too, right? So that's exactly right. So, you know, let's start with that.
So if you have an IRA that you inherited before 2020, it was under the old rules that allowed for a stretch over a lifetime. So you had a required distribution each year, but it would last for many, many years. And the opportunity to extend it over a long time was great. So in 2020, that rule changed. And that was, I think, because of the Secure Act, the original Secure Act. And essentially, there's three different kinds of scenarios you could find for different kinds of beneficiaries.
So we'll walk through them. And there's a lot of variations within them. And I'm going to do it in a different order than Ed Slott and his team did it when explaining this to our group. But, you know, so the first group that I want to talk about is the eligible designated beneficiary. And this is essentially someone who might be eligible to be treated like the old rules, the stretch IRA treatment. Now, this would not be a spouse, right? Or could it be?
Well, a spouse could be, a surviving spouse could be one of those circumstances where you could treat that. And incidentally, even these kinds of eligible designated beneficiaries who have the opportunity to treat it like a stretch IRA, they also have the option if they prefer to do it as a 10-year rule, which is the other more common approach now after the Secure Act. So they don't have to take it over the prolonged period of time.
I mean, the government is willing to let you pay taxes before you have to? You could opt to, exactly. So let's assume you're not a surviving spouse. And, you know, what are other circumstances where you could start the treatment as someone who could take it over, presumably, a lifetime with these stretch IRA treatment? Well, sort of a minor child. So think about this.
Someone who dies who is old enough to have required distributions, 73 or older, but dies with a minor child, someone under the age of 18. So not a lot of those, right? No, but some. We do hear stories, maybe a former Patriots football coaches or something like that. You never know. Well, it could be adoption, could be adoptions. There are different circumstances, a minor child, and it's not a grandchild, just to be clear, but a child under the age of 21.
So while they're under the age of 21, can do the stretch treatment. But once they exceed that age 21, they fall into the non sorry, the non eligible designated beneficiary category, which basically means they have the 10 year rule that applies. So once you get to a certain age, you age out of that stretch rule in that scenario. But a child, a minor child could be a stepchild. It could be an adopted child, could be a certain eligible foster child.
There can be some circumstances that might go beyond a biological child. So that pool is growing as you get more broadly defined. Yeah, add some of these different things. There was some clarifications that included more of these possibilities. There's also someone who is disabled, an individual who is disabled. And these are usually somewhat restrictive kinds of terminology.
But think in terms of maybe like a social security disability, not easy to be deemed eligible for social security disability benefits. It's that kind of, it's tough to get that. But if you have that kind of disability level, you could opt for this stretch IRA approach. I think it's probably clear, but just for make sure it is, we're talking about the beneficiary status here. So the beneficiary is disabled.
Who's exactly who's eligible to treat their inherited IRA over a lifetime, like a stretch IRA situation. Spouse, a minor child until they age out, a disabled person who has, you know, a more serious disability, chronically ill individuals. And that's a little more loose in the definition of that. And then individuals, not more than 10 years younger than the decedent, the person whose original IRA it was. So think in terms of a sibling, within 10 years.
And if you're older, let's say you inherit your siblings or friends IRA, and you know, you're two years older than your sibling, well, you're still qualify as not more than 10 years younger. Sure. Right. Okay. So those are various instances where you can use the stretch IRA still, and they refer to that as a eligible designated beneficiary. That's who gets to get into that category of that circumstance. So a little bit confusing, but.
It seems confusing enough that if you happen to inherit an IRA, you probably should, before you do anything, talk to your financial advisor and just see what category, if you're in this category somehow, right? Yeah, that's a good point. Because it would be preferable, if you could, to have the option to stretch it out over a long period of time. So there are going to be a lot of benefits of the tax deferral and the compounding and so forth.
Now, there's two other categories, because most people don't fit into that category, right? There's some, but most don't. Now, as we said, a spouse, it's a whole different thing. They can either turn it into their own IRA, and then it becomes their own issue, or they can continue to keep it as an inherited beneficiary IRA and have the option as to take it over a lifetime. And the rules for a spouse are a whole nother layer of complexity, because there's a range of possibilities.
A friend of mine, Bill Harris, even wrote a book on this topic, because there's so many different nuances. And the rules have changed. So it's even gotten more complex since he wrote the book. So in any case, let's keep that in mind. So OK, the least likely circumstance of the other two possibilities is the non-designated beneficiary. This is going to be someone who designates their estate, a charity, a non-person entity, maybe certain types of trust.
Some trusts have different characteristics than others, so it depends. But in effect, when there's not really a person-type beneficiary that's counted, there's really a five-year rule that applies. And if it was a charity, you can imagine they'd take it out right away. Sure, well, they're not subject to any tax. But this is one of those reasons why don't leave your IRA to your estate. Or maybe a trust.
This really steps into the estate planning portion of financial planning, because it's common for people who have a trust, they might name a spouse as the beneficiary, and then they might name the trust as a contingent beneficiary. And sometimes you don't update your beneficiary. Some people just name the trust. So this, in addition to your financial advisor, maybe it's talking to your estate planning attorney, too, to see if this impacts your... The right kind of choice you make, right.
And the terms of the trust are structured in a way to give you better treatment than the five-year rule. Now, I kind of simplified that, because it's actually more complicated than that. Of course. I think Alissa would know that by now. So the scenario I just described is when the person who had the IRA died after the required beginning date, after they were required to start their RMDs.
Now, the required beginning date is actually not just when you turn 73, but it may actually be generally the April 1st after you turn 73. So if somebody died even at 73, but let's say their birthday was, I'll just make it easy, in December of the one year, and they just turned 73, but they're technically... And they died, let's say, on their birthday, just to make life easy. So they might not necessarily be considered...or the day after their birthday, whatever.
They might not be considered having to met their required beginning date, because they actually could have opted to defer it until the next April 1st, within the rules. So in any case, a little bit in the weeds. But again, check before you make any decisions. Make sure you check. So if someone hasn't reached their required beginning date, what happens then is really... It's a little bit confusing.
So the required minimum distributions on the new...you know, the inherited IRA owner, what do they do? Beneficiary, right? Yeah. So it turns out, in that circumstance, they have to take out the required distributions over the deceased's single life expectancy table. Essentially, they call it a ghost life rule. So the distribution requirement is pretending that the deceased is still alive to calculate the distribution requirements, but on the single life table.
Now, is that a minimum that they have to do? Yeah. They could do more. I think so, yeah. They could take it all, like the other example. People generally don't...the IRS doesn't generally mind if you take it all. Right. So this could conceivably strike a circumstance where you might have less than 10 years to take that money out. Sure. Yeah, depending on how old the beneficiary is.
So if somebody died at, you know, 90, I don't know, you know, something like that, their single life table might be less than 10 years. Sure. Anyway, so that's a complicating factor. Most people, right, in these circumstances, the...now, and again, this was for non-designated benefi...estates, you know, if it's left to your state or if it's left to your certain types of trusts that don't qualify.
Some trusts do qualify because they see through to the...the right language is included and it sees through to the beneficiaries of the trust. Right. So the most people fall into this category, the non-eligible designated beneficiaries, and they have this 10-year rule that applies. So, essentially, the designated beneficiaries who do not fit into those other categories, grandchildren, adult children, some look through trusts.
They're going to be...and so most circumstances are going to fall into this group. Okay. So what happens here? We got two circumstances. The original IRA owner passed either before or after that required beginning date. So let's say they died before the required beginning date. Okay. So in that case, the inheritor of the IRA has 10 years to take the money out... Yep. ...but has no distribution requirements each year.
It's just...they can decide whether to take it all at the beginning, in the middle, at the end, take a little bit each year. It's up to them how they take it. At the end of the 10 years, in the year following the year that the person died, they have to have emptied the account, okay, to avoid the penalties. So someone could do some tax planning in this if they think they're in the low bracket now and might be higher later or the opposite? Let's come up with a scenario.
For example, dad dies, leaves me an IRA. I'm not a minor child. Right. I'm in my peak working years, and I've got maybe five years before I retire. Right. Well, maybe I don't really want to take distributions while I'm working, but once I retire, boy, my income is going to be lower. Maybe I'll take it then. Your tax bracket. I could take it all in the... Income and tax bracket, right. Yeah. I could take it all over those five years that are the last five years of it or whatever.
I mean, just you come up with different scenarios, but you have the idea. Yep. Okay. Now, what if we change that story? Same notion, same group of people. Dad dies and so forth. Well, in this case, dad was already receiving his RMDs. He started his RMDs. So I don't know if I made a good example when I did that a minute ago. But in this case, so dad is now 89 or 90 to 100, whatever. Whatever it is. I've got the stretch rules still apply for the 10 years.
I've got to take a little bit out each year, but I also have to have it emptied by the end of the 10 years. So because they started their distribution requirements, we can't stop them. The beneficiary stays on, in this case, the father's schedule, but it has to be emptied by 10 years? Not necessarily. That's a good point. Yep. So the point I'm making is because the father had started his distributions, the inheritor has to then continue to make distributions every year.
And once it gets started, it can't be stopped. Right? Right. So we have to take something. Now, the way that's calculated, to your point, is not actually based on dad's R&D. Okay. A good comment. It's based on the inheritor's life expectancy on a single life table. Different chart. Yep. Different chart. And then every year, we just subtract one from that factor to come up with what the balance of the value of the IRA was on December 31st of the prior year.
And we take that original year factor and subtract one, and now we divide by that number to come up with our distribution requirement this year, if that makes sense. Now, oftentimes, custodians don't really help you make sense of these, you know, what do I need to take this year? Where do I fit in these choices or these categories of things? So knowing the advisor that knows the right answers to these can be really important.
Not only do we have the benefit of going through these kind of classes and so forth, we have the back office resources of the Ed Slot team. And when we've got a really, really complicated case, we can just go to them and say, hey, walk us through, what are the issues here? But as you can see, you know, there's a lot of nuance to trying to navigate, which circumstance am I in, you know?
And there's other – one of the things that – we won't probably do this, Jeff, but there was this great case they walked through where an advisor said, here's a case we ran into and approached the team with their questions.
And it was all these variables that came into effect and worked out to save the client a lot, a lot of money that – by helping them navigate how to make some of these decisions when essentially in this situation a spouse died, had a work plan, the plan hadn't been looked at, you know, 10 years since the spouse died, but now the spouse's RMD age was coming into effect. They would have had to take distributions. So what should they do? The amount they had to take was very large.
The way the calculation was based on the surviving spouse's age. It came into all these complexities. They figured out a number of ways. They did an NUA. We talked about that topic not long ago. They made some decisions that allowed them to have a much more palatable approach to the whole process. They found there were some after-tax contributions in the work plan that allowed them to treat some of that differently as like Roth conversion or something.
So anyway, it was a really interesting case. But the point being, sometimes this stuff can get really complicated. And it's not just that you might withdraw some money too little or too late and have a tax, but there's penalties involved. Yeah, and some of these decisions you make could be meaningfully different in how you're taxed, whether you have to take it out faster or if you have the opportunity to take it slower.
Or in some instances, maybe you're better off for tax strategy, the timing of when you take it because of your own RMDs might be kicking in at a certain time, and maybe it makes sense to take some of that money sooner rather than later because of your own. It does make sense.
I'm thinking of one client that he had an inherited IRA, which he knows his own RMDs are coming at a certain date near in the future, so he actually accelerated the inherited IRA withdrawals because of a potential he would be getting two IRAs and his tax bracket would be at a much higher level. Yeah, you can just see how that could happen, right? So timing that and strategizing around that can really make sense.
And knowing the rules as to what you can do and what you have to do and the timing around those makes a difference. This is also another example of where you should consider your advisor part of your team.
And so you have your financial advisor talking with your tax preparer, talking to your estate planning attorney, and all making sure they're on a united front that this makes sense from a legal, from a tax, and from a financial planning standpoint and not just looking at solely the tax purposes, right? Because sometimes when you get these types of problems, you're just trying to avoid a tax issue. Yeah, exactly.
There may be estate planning opportunities of your own to take advantage of, and it may make sense to your financial plan. You mentioned a Roth conversion as part of some pre-tax money or post-tax money. So there's a lot here, and it makes sense to work with all of your team to make sure you get the right answer because it can have impacts beyond what you initially think.
So I tried to give a little bit of an explanation of this issue in a way that hopefully isn't too complicated, but granted, it's complicated. And so it's not an easy—this is the answer that always applies.
So in any event, hopefully that gives you a little bit of insight as to how you might need to think about things when it's your circumstances, that you're either—as you're thinking about who you assign as a beneficiary, why you might choose someone versus someone else, the rules they might treat around that, or if you're thinking about when you inherit funds, how to deal with them. These are two sides of the same coin, but these are important considerations.
And talk to your financial advisor, and if you don't have someone that you're working with, certainly reach out to our team. We'd be happy to be a resource to you anytime we can. Jeff, I know there's more things we can talk about. We'll save it for another time, and thanks, everybody, for being with us. Until next time, keep striving for something more. Thank you for listening to Something More with Chris Boyd.
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Wealth Enhancement Advisory Services and Jay Christopher Boyd provide investment advice on an individual basis to clients only. Proper advice depends on a complete analysis of all facts and circumstances. The information given on this program is general financial comments and cannot be relied upon as pertaining to your specific situation. Wealth Enhancement Group cannot guarantee that using the information from this show will generate profits or ensure freedom from loss.
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