Inherited IRA 10-Year Rule: Don’t Make This Costly Mistake

In today’s episode, you’ll learn more about:

• How the 10-year rule works for inherited IRAs
• When annual RMDs are required — and when they’re not
• Exceptions for eligible designated beneficiaries
• Key considerations when a trust is named as beneficiary
• Tax planning strategies to avoid bracket creep

Listen Now:

The Smart Take:

Go Inside the Episode: 

0:00 – Intro

0:45 – Ohio meteor

2:27 – Rules have changed

4:40 – Understanding the 10-year rule

8:05 – Different types of accounts

9:19 – Exceptions to the rule

12:04 – Trust as beneficiary?

14:36 – Tax planning during the 10-year window

 

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The Hosts:

Kevin Kroskey, CFP®, MBA – About – Contact

Tyler Emrick, CFA®, CFP® – About – Contact

Episode Transcript:

Tyler Emrick:

Have you inherited an IRA? Well, listen up. The old rules are gone and the new 10-year rules can create costly mistakes if you’re not careful. Because it’s not just about taking the money out, but when and how you do it. In this video, we’ll walk you through the new 10-year rule and how it actually works, when required distributions apply and how to avoid costly mistakes.

Walter Storholt:

It’s another episode of Retire Smarter. So glad you’re with us. I’m Walter Storholt, as always joined by Tyler Emrick. He is a Certified Financial Planner and a Chartered Financial Analyst, as well as one of the key wealth advisors at True Wealth Design, helping you all across the country, based out of Northeast Ohio. Where, before we dive into how the rules have changed a little bit about IRAs and stuff, you guys had a fireball in the sky not very far from you, Tyler, so I know that was the buzz of the office.

Tyler Emrick:

We did.

Walter Storholt:

We’ll jump to the financial talk in a moment, but I just had to bring that up.

Tyler Emrick:

Oh, no, I was right down the road. Big boom and I hear there’s going to be individuals that are probably going to be coming in looking for the meteorite.

Walter Storholt:

Okay, interesting.

Tyler Emrick:

So on the local news, they were like, “Hey, just a heads-up. If you see people walking around your area, they’re just searching. It’s very common for people to come in and do it.”

Walter Storholt:

Interesting.

Tyler Emrick:

I don’t know how common that is, but boy, if you’re not prepared for it and you just hear the big boom or see some of the videos of it shooting across the sky.

Walter Storholt:

Yeah.

Tyler Emrick:

It was quite the talk of the afternoon for sure.

Walter Storholt:

You’ll have to just believe me, but I’ve seen two in my life. I didn’t get them on video because they happened so quickly, but I’ve seen two and they’re pretty cool. One was during the daytime, which really blew me away, but was still pretty brilliant. Nothing had a boom, but I’ve seen the streaks-

Tyler Emrick:

I see, yeah.

Walter Storholt:

… in a similar fashion.

Tyler Emrick:

Well, the videos was daytime too, right?

Walter Storholt:

That’s right, yeah.

Tyler Emrick:

That’s when this one happened and it looked, to your point, it was very vibrant. You could totally see it coming through. But yeah, old Northeast Ohio.

Walter Storholt:

I saw another one at night and that one was really cool. That one was really cool.

Tyler Emrick:

But yeah.

Walter Storholt:

Nice.

Tyler Emrick:

But no, it’s good. And we had the solar eclipse just, what, a year ago or a year-and-a-half ago, which was pretty cool as well.

Walter Storholt:

Yeah, you were right in the zone for that.

Tyler Emrick:

I don’t know, all the-

Walter Storholt:

Northeast Ohio, the place to be for astronomical anomalies.

Tyler Emrick:

The place to be, yes.

Walter Storholt:

Yeah.

Tyler Emrick:

Absolutely, absolutely.

Walter Storholt:

The UFO disclosure is going to happen in your backyard if we’re reading the tea leaves appropriately here.

Tyler Emrick:

Yeah. No, absolutely. But much better than inherited IRAs.

Walter Storholt:

Yeah.

Tyler Emrick:

But hey.

Walter Storholt:

It is a little more fun to talk about, but we got to do it.

Tyler Emrick:

Yeah, absolutely, absolutely. So yeah.

Walter Storholt:

Well, this is a big thing because this used to be one of my favorite things. I loved the term the stretch IRA. I remember talking to Kevin in the early days of the podcast about stretch IRAs. And I don’t know, there was just something about a stretch IRA, I liked the term, I liked the idea of it.

Tyler Emrick:

Yes.

Walter Storholt:

It was pretty cool. But the rules have changed and I think that stretch piece of the puzzle is a little gone, right?

Tyler Emrick:

Yeah. No, absolutely. And this is going to be big for retirees thinking about their estate, thinking about family, where that money goes, who gets what and these rules certainly are going to have impacted and changed the way that we think about families’ estates and how we maybe set up beneficiaries and things like that.

Because to your point, getting these retirement accounts, specifically retirement accounts, that’s what we’re talking about when we say some of these rules around stretch IRAs and such. Yeah, we’d stretch it out over your lifetime. So if you inherited one, hey, you’d have small required distributions from the accounts each year, but you could stretch that out over the course of the remainder of your life and it really, the tax impact could be quite a bit muted. Whereas now, for most beneficiaries, especially family members, non-spouses, that window is much more condensed down to about a 10-year window for most, Walt.

Walter Storholt:

Yeah.

Tyler Emrick:

Which much, much shorter than what we were looking at before-

Walter Storholt:

Very different.

Tyler Emrick:

… for sure. So when we think about today what we want to talk about is, well, hey, we just want to peel back the onion a little bit, make sure you understand how these new rules work, how you can start to think about them in the framework of your actual estate or family and how they’re going to get it. So that way, if you need to make some changes or some tweaks, now is certainly the time to be able to do it and go from there. But I think it’s really important, I’ll say it again, hey, we’re talking about retirement accounts. Pre-tax IRAs specifically are the big ones that are going to be impacted the most because of course, when you pull money out of those, good old Uncle Sam gets a piece of it so those taxes become a bit of an issue, Walt, when we think about it.

Walter Storholt:

Yeah.

Tyler Emrick:

Especially for your inheritors.

Walter Storholt:

So timing is really the biggest change here and that’s what totally changes the strategies and changes the game because when you have essentially a lifetime to work with and you condense it down to 10 years, there’s no other way of putting it, it’s just a completely different scenario.

Tyler Emrick:

Sure. You inherit a million-dollar IRA account, well, hey, you’re taking a million-dollars of taxable income within the next essentially 10 years if you’re a non-spouse beneficiary. There’s some quirks and some changes there, which we’ll look at and you need to be mindful of, but we’re talking about most beneficiaries here.

And the way the rule specifically works. It’s saying, hey, accounts must be fully distributed by December 31 of the tenth year following death. So that is the big caveat. You inherit an IRA, 10 years to get it out, all of it hits your tax return as taxable income. So if you’re still working and you’re a high income earner, you inherit one of these from a family member, well, that income’s just going to stack right on top of your W-2 income or 1099 income that you have hitting your taxes each year.

One of the nuances that I think is extremely important is, well, how old was the individual who passed? Because that is going to affect some of those distribution rules. So either you are going to be in a situation to where, yes, you have 10 years to get out the money, but you do not have to do required minimum distributions each year, or you’re going to fall into the scenario where you are going to actually have to pull out required minimum distributions from that account each year.

So required minimum distributions, simply put, Walt, that is just … For the listeners over 73, you know intimately what required minimum distributions are. That’s when the IRS makes you start pulling money out of your IRA accounts because they want you to pay taxes on it. Same thing here with the inherited IRA accounts. You inherit one of those, yes, you got that 10-year window, but each year you will likely have to pull out a certain amount at a minimum. You could pull more and you might want to depending on your tax strategy, but there is certainly a minimum amount that you would have to pull out. And all of that-

Walter Storholt:

So you could, in year one, your million-dollar example, you could pull out all million in year one-

Tyler Emrick:

You could.

Walter Storholt:

… if you wanted to. What you can’t do is wait nine years and then pull out the million in the last year. There’s going to be some sort of prescribed minimum to take each year.

Tyler Emrick:

Correct.

Walter Storholt:

Yeah.

Tyler Emrick:

And that minimum will not get the account depleted by 10 years. So you are going to have to certainly pick and choose years where you’re going to have to pull out a little bit more.

Walter Storholt:

Okay.

Tyler Emrick:

And how that rule applies to you specifically if you inherit one of these accounts has everything to do with the individual who passed, how old they were. They got a little bit of a tongue twister here, but they use what’s called a required beginning date, or RBD. Not RMD.

Walter Storholt:

Wait, don’t you mean RMB?

Tyler Emrick:

Yeah, no. Which is essentially, hey, if the original owner was taking required minimum distributions over 73, for most circumstances then you’re going to have to pull out those RMDs each year and then at year 10, have it distributed.

Walter Storholt:

Okay.

Tyler Emrick:

So a big tax bomb potentially hitting when we can think about that.

Walter Storholt:

Yeah.

Tyler Emrick:

Now, there is one little caveat here we might as well bring up too, is there are different types of retirement accounts so we want to be mindful of that. The big difference is, hey, we’ve got these Roth IRAs and we’ve got traditional IRA accounts, which are pretax. Roths are a little bit different. Roth accounts, you do not have required minimum distributions each year that you have to pull from. You can actually wait all 10 years and then at the end of 10 years, pull everything out of that inherited Roth IRA.

Which, for most individuals, Walt, if you don’t need it, it would probably be the route to go because those Roth accounts do continue to grow tax-free. So any interest or gains from investments that you can get inside of that inherited Roth, well, hey, you’re going to get that and you’re not going to have to pay taxes on it when you distribute it at the end of year 10. So those Roths are wonderful tools, we talk about them all the time on the podcast. But if you do inherit one of those, the tax bomb isn’t going to be there so you just need to think about, “Well, how do I use this and how does this fit into my overall financial picture?”

Walter Storholt:

Yeah, makes sense.

Tyler Emrick:

Yeah.

Walter Storholt:

They didn’t really need those extra acronyms, it sounds like.

Tyler Emrick:

No, not at all.

Walter Storholt:

It’s just are they taking RMDs or not when they pass away.

Tyler Emrick:

Yes.

Walter Storholt:

Yeah.

Tyler Emrick:

So for those individuals listening, there are a few circumstances where you can still stretch out payments-

Walter Storholt:

Okay.

Tyler Emrick:

… over your life. So I think it’s important that we at least mention those. The biggest one would be if you inherit something from a spouse. Inheriting an IRA from a spouse, you can stretch distribution payments out over your lifetime. You can also move that money into an account underneath your own name and not have it be an inherited IRA or an inherited Roth. Minor children are another individuals that aren’t necessarily subject to the 10-year rule. Disabled or chronically ill individuals.

And then this fourth one here is a big one that I run into quite a bit, or at least one that I’ve run into a lot for the last couple years. And this is if you are a beneficiary and you’re within 10 years of the decedent’s age. So I ran into with I had longtime client a few years ago passed away and her sisters essentially inherited the IRA accounts. All of her sisters were within 10 years of her, so they were able to make that special stretch election and that provides just flexibility, Walt.

If you can do that, you likely want to because why have this big 10-year wall looming to have it out? There’s nothing that says when you stretch it out over your lifetime that you can’t take it out earlier, so that is really where we would like to be. If we can make that election and handle our inherited accounts that way, that provides the most flexibility for individuals.

Walter Storholt:

Yeah. Why turn down flexibility if you can get it?

Tyler Emrick:

Absolutely. But that’s a big one. And this is something to where, if you find yourself in a situation to where you are inheriting these accounts, understanding when these eligible designated beneficiary exceptions stand out and do they apply to you can really add quite a bit of value and save you a boatload in taxes over the long run or really determine how you use these accounts for sure.

Walter Storholt:

One quick question on the minors. That’s not necessarily … You mentioned them as an exception, but that’s not for the rest of their lives. Does it just mean their 10-year window doesn’t start until they become no longer a minor?

Tyler Emrick:

At the age of majority.

Walter Storholt:

Okay.

Tyler Emrick:

Correct.

Walter Storholt:

Gotcha.

Tyler Emrick:

Yeah, absolutely. Absolutely. And that age of majority is different, right?

Walter Storholt:

Oh, okay.

Tyler Emrick:

From each state, so it can be a little bit different. It absolutely has some quirkiness there as well.

Walter Storholt:

Is 18 kind of the common one?

Tyler Emrick:

Yeah.

Walter Storholt:

Or is that a good assumption at least? Okay.

Tyler Emrick:

Yeah, 18’s a general rule, but definitely look it up in your state.

Walter Storholt:

So if you’re 10 and you inherit, you essentially have an 18-year window if your state is 18.

Tyler Emrick:

Correct.

Walter Storholt:

Then you have the eight years to get to 18 and then your additional 10 years.

Tyler Emrick:

And then you’re on it.

Walter Storholt:

Got it.

Tyler Emrick:

Yeah, exactly right. Exactly right. Well, and this is a big thing too when we start thinking about, well, hey, if you’re looking at all your accounts and you’re thinking about these new inheritor rules, well, who do you set up as beneficiaries on these accounts? I do get a lot of questions, Walt, all the time. Like, “Well, hey, I have this trust. Should the trust be a beneficiary-”

Walter Storholt:

Okay.

Tyler Emrick:

… “as opposed to my children?”

Walter Storholt:

Interesting.

Tyler Emrick:

On these accounts. And with the Secure Act passing and some of these laws changing, well, the trust rules now are a little more convoluted and add a few more quirks that you definitely need to be aware of. Because if your trust is not set up within a certain way, what happens is is that 10-year rule can actually be compressed down to five.

Walter Storholt:

Okay.

Tyler Emrick:

So you have five years to get that money out, as opposed to the stretch of 10, or stretching it out over a lifetime. So normally, these would be terms like, well, does your trust qualify as a see-through trust? How was your trust set up? Was it a conduit trust or accumulation trust? So these are all buzzwords-

Walter Storholt:

Yeah.

Tyler Emrick:

… that are out there. Certainly, if you have-

Walter Storholt:

This is where the estate planners really start to geek out, right?

Tyler Emrick:

You got it. So if you’ve created a trust 10 years ago, you haven’t made any updates, you got the trust as a beneficiary on your IRA, absolutely this is your trigger to say, “Hey, maybe I should just look at how is my trust set up? Is it a see-through trust? Is it an accumulation trust or a conduit trust? What are some of the rules based off how that trust is written and how do those rules apply to the new Secure Act and how the inheritors are going to have to distribute money?”

Because again, you think about, hey, you got your trust as a beneficiary, the trust is going to split it between your two kids. The trust wasn’t maybe set up in light of the new laws. Hey, now your beneficiaries have to pull that pretax IRA account out in five years as opposed to 10. You could see where the tax issues could come into play here for sure.

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Walter Storholt:

I guess this is the dumb question, but this would be where I would imagine someone who’s not well versed perhaps in trusts or in taxes and all of those financial consequences, they might say, “Well, I got to pull it out within 10 years. At some point, really, how much strategizing can I do? How can we really adjust these levers?” What’s the big deal about having to make this such a big piece and important part of the planning discussion? How big of a deal is this? Are we talking about just saving a couple of hundred dollars by doing something?

Tyler Emrick:

Sure.

Walter Storholt:

Or are we talking about something more significant?

Tyler Emrick:

Great question and I think it can be very significant. Especially when you start thinking about how a lot of retirees, they put money in 401Ks for years. These account balances in these 401Ks, and IRAs and pretax retirement accounts can get pretty substantial. You start inheriting that or even a portion of it and hey, you have to pull out a half-a-million-dollars within 10 years.

Well, when we think about how that’s taxed, it’s ordinary income like we’ve mentioned before. So you can think of that as, well, the higher your ordinary income is, you could jump into the next tax bracket or the next tax bracket. You could jump from paying 22% in taxes on that distribution to 32% in taxes on a portion of that distribution. So I think the tax bracket management, tax bracket management, that’s a mouthful, but essentially that’s just a basic way of saying, “Well, hey, what’s my distribution plan? How am I going to get this money? And I got this 10 years that I need to make sure that the account’s zeroed out there, but I got some flexibility here. Is my income going to change over the next handful of years? How much room do I have before I jump to the next tax bracket?”

Hey, I normally fall in the 22%, I could take X amount more of income before I jump to the 24% bracket. Well, is that difference enough for me to get the account distributed over the next 10 years or am I going to have to go into the next bracket one year? And how does that interplay work?

Obviously, if you need the money or something like that comes in, you need the cash. But as you think about, well, hey, I don’t want to send anymore to good old Uncle Sam than what I have to, that’s where that distribution plan and where working with a good advisor, or if you know your tax situation and you can work that out. But getting down into doing those distribution schedules and how to distribute it, I think there’s a lot of value add there to where, hey, you pull it all out at once, maybe you’re paying 30-some percent in taxes on everything, where if you spread it out over 10 years, maybe you only pay 22% or lower as an example.

Walter Storholt:

Yeah.

Tyler Emrick:

You start looking at a 10% savings over a million-dollar account-

Walter Storholt:

On a million dollars, that’s $100,000 that you’ve saved if it’s that 10% delta. Yeah, okay.

Tyler Emrick:

It adds up. So I think that’s where, as you think about if you’ve found yourself in a situation where you’ve inherited these, well, hey, what type of beneficiary am I, 10-year rule or stretch? And then, all right, I got to work within that framework. How can I build a distribution plan to do it in the most tax efficient way possible?

Walter Storholt:

It’s fun to think about this stuff, Tyler, but I’m hoping the good news here is that if I work with you, you’ll just do this for me, right?

Tyler Emrick:

Absolutely.

Walter Storholt:

And tell me which one is the best path, or at least narrow it down to two options for me.

Tyler Emrick:

You got it. Yeah, that’s exactly what a good financial advisor’s job is there to do. It’s not like, “Hey, consult your tax advisor. I don’t know. Hey, it’s a good pot of money, I can manage it for you.” No. It’s like how does it fit into everything that you’re doing, and what’s the most efficient way for you to use this money and follow the rules that you need to?

Walter Storholt:

Beautiful. Well, folks, here’s what you need to do to schedule a time to meet with Tyler and the great team at True Wealth Design and you can have a discovery call. Especially if you have an inheritance that maybe you know is coming down the pike or you’ve recently inherited some money, or even if you’re the one worried about passing on that inheritance.

Tyler Emrick:

Thinking about it for your kids or family.

Walter Storholt:

Yeah.

Tyler Emrick:

Yeah, you got it.

Walter Storholt:

Because you can go ahead and start prepping things on your end of the equation, too. So no matter what side you are on there, if you’ve not gone through deep, intentional financial planning before, now is a great time to do so, especially if you have something like this on the horizon.

And so you can take advantage of a 20-minute discovery call with the True Wealth Design team. All you have to do is click the link in the description or go to truewealthdesign.com and click the Let’s Talk button and you can schedule that time to meet from wherever you are. The team’s based in Northeast Ohio, but they serve clients all across the country, they can meet with you remotely. So don’t hesitate to reach out if you have any questions, and want to explore this a little bit and just see if you’re a good fit to work with one another and where some of the opportunities are. Check that out.

Tyler, thank you so much for the help today. We’ll talk again soon.

Tyler Emrick:

Absolutely.

Walter Storholt:

All right. Go find some more fireballs, go look for that meteorite.

Tyler Emrick:

We will try our best.

Walter Storholt:

We’ll see everybody next time, right back here on Retire Smarter.

Disclaimer:

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