Understanding How Inherited IRA Rules Impact Taxes is Essential to Wealth Management
Oftentimes, new clients come to us after realizing they or a previous financial advisor missed a crucial action step that would have maximized their tax savings. One such situation recently occurred for a client who was not told about the 10-year-distribution rule on inherited IRAs until they met with our Storen Financial advisor.
What is the 10-year distribution rule on Inherited IRAs?
In the wake of the SECURE Act, the “stretch” IRA is no longer available to most non-spouse beneficiaries. Only eligible designated beneficiaries (EDBs) have this option. However, non-spouse beneficiaries who are not EDBs are not forced to take a lump sum distribution. Instead, most non-spouse beneficiaries will be able to spread distributions from an inherited IRA over a 10-year payout period. Annual RMDs may be required during the 10-year payout period if the original IRA owner died on or after their required beginning date. (Click here to learn more about this rule.)
Client’s Child Lost the Potential for Years of Tax-Free Growth in IRA
A new client came to one of our Storen Financial advisors with questions about an IRA she had inherited from her late spouse. Her previous advisor with another firm had recommended she disclaim (or legally refuse to take ownership of) the Roth IRA to her child. Unfortunately, this was negligent advice. Since the child was not an EDB, the money will have to be taken out in the next 10 years even though the mother is still alive. This means that the child missed out on the opportunity for years of tax-free growth.
Our team would have recommended an alternative route with the opportunity to benefit the family overall. The Roth should have been left in the widow’s name where the money could accrue tax-free. Then, when the widow passes away, her child (as the beneficiary) could let that money sit in the account and grow for another 10 years tax-free (i.e. the stretch IRA). Once that 10-year mark hits, the advisor could close and liquidate the account with no penalties.
So, if the widow lived another 10 years, and the child had kept the money in the account for an additional 10 years after inheriting it, that’s a 20 year tax-free growth opportunity. Although it may seem like it made the most sense for the widow to disclaim the inherited assets so that her child could have them right then, in the end, it was a decision that cost the child a decade of potential tax-free wealth accumulation.
Deciding what to do with money from a recently deceased loved one is difficult on top of the already emotional process of grieving. That’s why we’re here to walk you through the process, keep you updated on all potential tax benefits, and help maximize what you leave behind. At Storen Financial, our Advisors regularly study complex tax laws and undergo rigorous training through Ed Slott’s Elite IRA Advisor Group, meaning we’re trained not to overlook minute details and strategies like the 10-year distribution rule. We want you to understand our tax-saving methods for building and diversifying your portfolio. For that reason, we happily sit down with clients to answer your toughest questions and help you spot strategies you may have missed, with the goal of instilling the confidence and knowledge you need to place your trust in our team and what we do.
Have questions? Or interested in meeting with our Storen Advisory team? Click here to contact us now. Or click here to learn more about our Financial Planning Investment Services.
Blog by Greg Storen, MBA – President/CEO, Advisory Services Director
Learn more about Greg and the rest of the Storen Financial team here.
This is a hypothetical situation based on real life examples. Names and circumstances have been changed. To determine which investments or strategies may be appropriate for you, consult your advisor prior to investing. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.