In this episode of Protecting and Preserving Wealth, we delve into the updated 10-year IRA rule for beneficiaries, finalized by the IRS on July 18, 2024. Under the old Strech IRA rules, beneficiaries could stretch out Required Minimum Distributions (RMDs) over their lifetimes, creating a favorable tax strategy for passing on wealth. However, with the finalization of the SECURE Act regulations, the 10-year rule now applies, requiring beneficiaries to thoroughly distribute inherited IRAs within 10 years, limiting the potential for long-term legacy planning.
The rationale behind this change is to ensure the IRS receives its share of taxable income more quickly, as opposed to waiting decades under the stretch IRA framework. This shift in perspective also means that the IRS no longer views the passing of retirement savings to the next generation as something that should be drawn out over time.
We also explore the nuances of the required beginning date for RMDs, which has been extended to age 73. However, clients are advised to start taking distributions IN the year they turn 73 rather than waiting until the following year to avoid doubling their taxable income from this source. If an IRA owner dies before their RBD, no RMDs are required during the 10-year window. Still, the entire account must be distributed by the end of that period. Conversely, suppose the owner dies after their RBD. In that case, beneficiaries must continue taking RMDs based on their age, and any delays could result in substantial tax hits later on.
We stress the utmost importance of proactive planning, particularly for beneficiaries of large IRAs who may face significant tax burdens if they wait until the 10th year to withdraw funds. A million-dollar IRA, for example, could double in size, leading to a massive taxable distribution. To mitigate this, it’s often beneficial to take distributions gradually.
Finally, we touch on the benefits of Roth IRAs in this context: While Roth IRAs are also subject to the 10-year rule, they are not subject to RMDs during that time, allowing tax-free growth for the entire period. Beneficiaries should wait until the end of the 10 years to maximize tax-free withdrawals.
In conclusion, the new 10-year rule presents challenges, but with careful planning, including the strategic use of Roth IRAs, beneficiaries can still preserve wealth efficiently. For personalized advice, we encourage listeners to reach out to Hosler Wealth Management.
Call the Prescott office at (928) 778-7666 or our Scottsdale office at (480) 994-7342.
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Guest Profile
Alex Koury CFP®, CERTIFIED FINANCIAL PLANNER® professional and Wealth Manager in Scottsdale, has worked in the financial services industry for fifteen years as a financial advisor and Financial Planner. He holds Series 7, 9, 10 & 66 securities registrations– and is a Registered Representative with Commonwealth Financial Network®.
Podcast Host
Bruce Hosler is the founder and principal of Hosler Wealth Management, LLC., which has offices in Prescott and Scottsdale, Arizona. As an Enrolled Agent, CERTIFIED FINANCIAL PLANNER® professional, and Certified Private Wealth Advisor (CPWA®), Bruce brings a multifaceted approach to advanced financial and tax planning. He is recognized as a prominent financial professional with over 27 years of experience and a seven-time consecutive *Forbes Best-In-State Wealth Advisor in Arizona. Bruce recently authored the book MOVING TO TAX-FREE™ Strategies For Creating Tax-Free Retirement Income And Tax-Free Lifetime Legacy Income For Your Children. www.movingtotaxfree.com.
In the Protecting & Preserving Wealth podcast, Bruce and his guests discuss current financial topics and provide timely answers for our listeners.
If you have a topic of interest, please let us know by emailing info@hoslerwm.com. We welcome your suggestions.
*2018-2024 Forbes Best In State Wealth Advisors, created by SHOOK Research. Presented in April 2024 based on data gathered from June 2022 to June 2023. 23,876 were considered, 8,507 advisors were recognized. Not indicative of advisor’s future performance. Your experience may vary. For more information, please visit.
Transcript
Speakers: Jon Gay, Bruce Hosler, & Alex Koury
Jon Gay (00:04):
Welcome back to Protecting and Preserving Wealth. I’m Jon JAG Gay. I’m joined by Bruce Hosler and Alex Koury of Hosler Wealth Management. Gentlemen, great to be with you.
Bruce Hosler (00:11):
Great to be with you today, Jon.
Alex Koury (00:14):
Hey Jon.
Jon Gay (00:14):
Today we’re talking about the IRA 10-year rule for beneficiaries. The IRS just finalized the new rules on July 18th of this year, 2024. Where do you want to start, Bruce?
Bruce Hosler (00:24):
So, let’s just start with that. We had all those SECURE Act rules come out on the IRA rules. They were proposed regulations at that time and people don’t realize when the proposed regulations come out, those are the regulations that we have to follow even though they’re not finalized.
But now they have finalized them, and it caught a lot of people off guard. Now, prior to those SECURE Act rules from 2020, we used to have the old stretch IRA, and a lot of people remember those rules.
Alex, talk to the folks about how the old stretch IRA used to work when parents used to die and leave their IRA to their kids.
Alex Koury (01:07):
So, the way it previously worked, when a parent died and passed on those IRA assets to their children, the children were actually able to take out a small required minimum distribution based on their actual age, and they can stretch that out over their entire lifetime.
And then when they pass away, if their children were inheriting those IRAs as an example, then the children could continue on those IRA RMDs for over their lifetime, potentially, just as well. So, it was a great tax strategy just to allow small amounts of money to be tax at ordinary income rates. And it was a great way for everyone to get their money as an inheritance without a big tax burden.
Bruce Hosler (01:45):
And you talk about a legacy, what a great legacy if you have an RMD of 4 or 5, 6% and your account is earning 7, 8, 9, 10%, the IRA could continue to grow during your child’s life, leaving a longer stream of income to your children. It was a great legacy tool.
But unfortunately, with these finalized regulations, we’re now subject to the new 10-year rules. And the 10-year rule basically says that once you die, your IRA has to be distributed within 10 years. This whole idea of leaving a lifetime legacy is shut down.
The IRS gets their distribution in just 10 years no matter what. That’s the worst case. So, it basically ruined the ability to leave a stretch IRA for the rest of their lives.
Jon Gay (02:43):
Bruce what you just said about the IRS is exactly what I was thinking. That the idea behind this had to be, that if folks were able to just pick off a little piece of this every year for even into a next generation, the IRS wasn’t getting their piece of the pie.
So, my guess is the mentality behind this was, you know, we’ve talked about the shortfall that the government’s facing down the road. The IRS wanted to get their money.
Alex Koury (03:04):
That’s part of it. And the other part of it as well, is that the IRS doesn’t believe any longer that if … so if you worked all your life and you saved up all this money in your 401(k)s and the IRA accounts, you earned that money, that was yours.
And now they no longer believe that that should be passed on to future generations because that generation inheriting the money didn’t actually earn that. And that’s another reason why they’re trying to really empty out these accounts. But there’s also those tax reasons why with our debt being as high as it is that they want their money.
Bruce Hosler (03:32):
Let’s talk about the RBD. So, the RBD is your required beginning date. It used to be 70 and a half and everybody was confused. Why is it a half year? Just like the 10% penalty, you have to be 59 and a half. You can’t be 59. It’s 59 and a half and it used to be 70 and a half.
Well, with these new regulations, they have now extended the required beginning date for your required minimum distributions to be age 73. But your required beginning date is actually the year after you turn 73 – on April 1st of the year after you turn 73. That’s your required beginning date.
And I said April 1st, not April 15th, folks. Don’t make that mistake. It’s April 1st. That’s your required beginning date.
Now Alex, why do we not recommend to our clients that they wait until the required beginning date? Why do we want them to take their distribution the year they turn 73?
Alex Koury (04:38):
We want them to take it then because if you wait until the year after that, then you’re basically double taxed on two RMDs in that one year.
Bruce Hosler (04:45):
That’s right. You have to double up your income. And we don’t want them to do that.
So, what if a client dies prior to their RBD? What are the rules for the RMDs for those clients, Alex?
Alex Koury (04:59):
So, the rules are that if an owner dies before the required beginning date, that there are no annual RMDs during that 10-year window. However, at the end of the 10 years, the full account balance must be distributed.
Bruce Hosler (05:14):
So, if they haven’t taken it out yet, that is the IRA owner, if they haven’t started to take the RMDs, the kids don’t have to continue those RMDs. So, the “ALA Rule”,” or “at least as” rule applies, so once someone passes their RBD, now they’ve started taking RMDs.
And what the IRS has said with this new rule is, “Hey, if you’ve started RMDs, we want it to be at least as much as,” and the amount is not the same because it’s based on the beneficiary’s age. So, we have to look at the charts, but they have to continue to take those distributions.
Now Alex, we just saw the regulations here, we look at what’s going on with the waivers. We’ve had waivers since 2020, ‘21, ‘22, ‘23. And now the IRS just came out and gave us a waiver for 24. So, people that inherited IRAs, they’ve had these waivers for five years.
Alex Koury (06:15):
That’s right.
Bruce Hosler (06:16):
What happens next year in 2025 though, Alex? What has to happen now?
Alex Koury (06:21):
So, what has to happen at this point, if the owner died, again, after the required beginning date and they were beginning to take their RMDs and you inherited that IRA, you’ve got to play some catch up because now you’ve only got, let’s say, five years left to go before that money must be distributed.
So, you had these waivers all these other years, there’s a pass. But now the IRS is saying, now it’s time. You need to start taking out your RMDs every year and getting the money out of that account.
Bruce Hosler (06:47):
Well, let’s think about it folks. If you had a million-dollar IRA and you left it to your child, they’ve had waivers for five years, they haven’t been taken any out. That million-dollar IRA’s probably grown and now they have five years, that means at a minimum, they probably have got to be taken out $200,000 a year on top of their other income. On top of their other income.
Jon Gay (07:11):
What you’re saying here, Bruce, you mentioned a moment ago, the 10-year waiting period if somebody passes before their required beginning date, and now you’re also talking about the five years of waivers that we’ve had.
The same concept is kind of at play here- where if you’ve had years where you haven’t taken the money out, you’re going to end up with a big whack later on. You’ll have to take out a bigger chunk and thus pay more taxes on it.
Bruce Hosler (07:33):
Jon, you have hit the nail on the head. Think about these people that think, “I don’t have to take RMDs, so I’m going to wait until year 10.” And then they’re going to pull out a million dollars.
I mean, let’s think about it. If you have a million dollars and you achieve a 7% rate of return in the markets, if we consider the rule of 72, that million has grown to 2 million, now your kid has to take out $2 million of IRA taxable money in the 10th year after you die.
Jon Gay (08:04):
That’s quite a hit.
Bruce Hosler (08:05):
What a catastrophe.
Jon Gay (08:06):
Yeah.
Alex Koury (08:07):
And that easily puts someone at the top tax rates. So, again, today the top marginal tax rate is still at 37%. That’s going to sunset in two years from now; that’s going to tick higher. So, now you can keep adding more dollars that go towards the IRS. You keep a portion, but they’re going to get a bigger chunk.
Jon Gay (08:23):
So, it sounds guys like you’re talking about, especially when you mentioned the higher tax bracket on a bigger chunk of money, Alex, that if you have the ability to gradually draw this down as opposed to in a lump sum later on- that, in a lot of cases that’s the way to go.
Alex Koury (08:37):
It can help.
Bruce Hosler (08:38):
Absolutely. It can help them stay in a lower tax bracket and help them do other things. Now the last thing I want to talk about on this topic is what if you as a parent, you have your IRA, you’ve converted it to a Roth, does that Roth IRA, Alex, does that have required minimum distributions?
Alex Koury (08:58):
It doesn’t.
Jon Gay (09:00):
And that’s because you’ve already paid the taxes on the way in. Right?
Bruce Hosler (09:02):
So, the rule that really applies there, Jon, is the IRS considers if you have a Roth IRA that you died before your required beginning date, before your RBD. So, if you have a Roth, you’re always considered that way. So, there’s no annual, but you are still subject to the 10-year rule.
But think of it in the reverse of what we just said. So, if you have a taxable IRA and you’re a child, you’re what they’re going to call a non-eligible designated beneficiary. If you’re a child that has to take it out over the 10 years, you should start taking it out over those 10 years, so you don’t have a big pile at the end of the 10th year.
In the reverse on the Roth IRA, when should those kids take out that Roth IRA? When would be the ideal planning opportunity, Alex?
Alex Koury (09:50):
Well, you want to wait until that 10th year because you get 10 years of growth. Assuming again, let’s say the rule of a 72, you can compound it over seven years.
Bruce Hosler (10:00):
10 years, over 10 years.
Alex Koury (10:01):
Over 10 years. You’ve got the Roth irate doubling to $2 million, and at end of the 10 years you take out $2 million tax free.
Bruce Hosler (10:10):
Absolutely. And you can wait folks until the very last month of the calendar year that the person after they died. So, it’s 10 years later, they can wait until the very end of the year. So, you can let it grow all of that year income tax free.
And that’s my message for our podcast today, is that if you leave a Roth IRA to your children, you need to encourage them to not touch it and leave it grow all the 10 years after you pass away.
Jon Gay (10:40):
Great advice. And this stuff is always changing. We talked about at the beginning of the podcast that the IRS rules just got finalized within the last several months here.
I know you and your team at Hosler Wealth Management are always on top of these things and helping people tailor plans to their individual situations. Alex, Bruce, if someone wants to come talk to you and the team, how do they best find you at Hosler Wealth Management?
Bruce Hosler (11:00):
Well, on Prescott, they can find us at (928) 778-7666, in Scottsdale, (480) 994-7342 and certainly on the web at our website, hoslerwm.com.
Jon Gay (11:16):
We talked about Roth IRAs and regular IRAs. And next episode we’re going to talk about why your kids won’t be able to convert your IRA to a Roth IRA. We’ll talk to you next time.
[Music Playing]
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