If you’re a regular reader of this column, you probably know that I’m a die-hard Red Sox fan. Right now, while it has been a tough August, the Cutter household is hoping for a turnaround going into September. You know, I was a pretty good ball player in high school myself, too; I played center field. And I seem to have passed on my passion for the game to my daughters. Phoebe and Maeve in particular has picked up interest in the sport. Heck, Maeve is off to play at Quinnipiac after an unbelievable high-school career, and how about Phoebe who just picked up MVP and the #1 ranked softball pitcher on Cape Cod. I couldn’t be prouder. Even though Sophie left softball for a wonderful lacrosse high school career, she still likes going to the Sox game with her old man. Of all the things I can pass on, this one is satisfying because it’s something fun that we all have in common.
As we chatted this past weekend about the Sox’s recent performance, I got to thinking about some of the other things we pass on. And as a finance guy, of course my mind went right to business. I thought about numerous conversations I’ve had with folks who were surprised to find out that the rules had changed for passing on their IRA upon their death. With the passage of the SECURE Act in 2019, bequeathing your IRA to your loved ones comes with some strings attached. So this week with our time together, I’d like to dig into some considerations if your legacy plan includes an IRA.
An IRA, or Individual Retirement Account, can take one of two forms – the traditional IRA and the Roth IRA. Both are designed to help you save money for retirement but have different tax features and advantages.
There are specific rules that you need to follow depending on what IRA type it is and what type of beneficiary you are. Your distribution options will vary, being more favorable for a spouse beneficiary vs. a non-spouse.
Let’s start with a spousal beneficiary. If your spouse dies and leaves you his or her IRA, you’re not allowed to just leave the funds in their name. However, you will have the option to transfer the money from their IRA to your own (or open a new one if you don’t already have one). This is commonly called a Spousal Transfer. Once transferred, you may manage the withdrawals as if the money were always yours. For a traditional IRA, your Required Minimum Distributions (RMDs) must begin at age 72. The same process works for a Roth IRA as well – the only difference here is that Roth IRAs don’t require RMDs for owners, so withdrawals are optional.
Another option for spousal heirs who inherit an IRA might be to transfer the assets into an Inherited IRA. This option is different from the spousal transfer. In this situation, the easiest option is open an Inherited IRA with the same financial institution that held your spouse’s IRA.
At this point you can access the funds in two ways. The first is called the “life expectancy method” where you take annual distributions based on your own life expectancy, not your spouses. This strategy is often called a Stretch IRA because you stretch distributions over your life-expectancy.
The second option is called the “10-year method”, where you have to withdraw all funds within a decade. One of the benefits of choosing an inherited IRA is that if you take a withdrawal before age of 59 ½, you will not be subject to the 10% early-withdrawal penalty.
Unfortunately, if you’ve inherited an IRA from someone who isn’t your spouse, well, this is where the SECURE Act had the biggest impact. It essentially eliminated the stretch IRA for non-spousal heirs who inherit the account on or after Jan. 1, 2020. The funds from the inherited IRA – either a Roth or a traditional IRA – must be distributed within 10 years of the original owner passing away. There isn’t a specific amount that you need to withdraw each year, the only requirement is that the account be emptied by the 10th year.
There are a few exceptions. For example, if you are a minor, disabled, chronically ill or not more than a decade younger than the original owner, you will still have the option to withdraw the funds using the stretch IRA method. This means taking distributions based on your own life expectancy instead of having to take them all within 10 years. If you are a minor, it gets switched to 10-years when you reach the age of majority.
Of course, regardless of whether you’re a spouse or not, you always have the option to take the funds in a lump sum from either a traditional or Roth IRA.
The real issues here regarding inherited IRAs really boils down to the taxes. Being forced to take a distribution if you don’t need it can impact your overall tax situation. This is particularly important with a traditional IRA, which was funded with pretax dollars. Any distribution will be taxed as income and could bump you up into a higher tax bracket.
This is not the case with an Inherited Roth IRA since it was funded with after-tax dollars, so you’re not taxed on distributions. You could pay taxes on Roth earnings in some cases.
Folks, we just touched upon the basics of Inherited IRAs here; if you find yourself in this situation, make sure you reach out to a retirement professional so you know all of the facts. Not understanding the IRS rules could set you up for heavy penalties. So before you accept that inheritance, do your homework and understand all of your options.
You know, legacies are important; as I get older I often think of what my legacy will be to my three girls. I hope they remember me as hard-working, honest, high integrity, God loving, caring, good husband, all that good stuff. Because I will tell you one thing, they better not be counting on an inherited IRA because Jill and I plan on spending everything!
And as always – be vigilant and stay alert, because you deserve more!
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield, MA. Insurance offered through its affiliate, CutterInsure, Inc. We do not offer tax or legal advice. Jeff can be reached at jeff@cutterfinancialgroup.com. This information is intended to provide general information. It is not intended to offer or deliver investment advice in any way. Information regarding investment services is provided solely to gain a better understanding of the subject of the article. Different types of investments involve varying degrees of risk, including the potential for loss. Therefore, it should not be assumed that future performance of any specific investment or investment strategy will be profitable. Insurance product guarantees are backed by the financial strength and claims-paying ability of the issuing company. Market data and other cited or linked-to content is based on generally-available information and is believed to be reliable. Cutter Financial does not guarantee the performance of any investment or the accuracy of the information contained in this article. Cutter Financial will provide all prospective clients with a copy of Cutter Financial’s Form ADV 2A, Appendix 1, applicable Form ADV 2Bs and Form CRS as well as the firm privacy policy. Please contact us to request a free copy via .pdf or hardcopy. 1.
