Inherited IRAs – HumbleDollar

The financial news is filled with angst over the death of the stretch IRA, something most people never heard of. Take a deep breath, it’s not a crisis. Here is an article that puts the issue into perspective.

YOU MIGHT HAVE heard financial experts claim that IRAs, 401(k) plans and other retirement accounts are terrible assets to bequeath, because the government will end up with more than 80% of the money. This is just a scare tactic by financial advisors trying to drum up business: Unless you’re subject to federal estate taxes and the account’s beneficiaries are in the top income tax bracket, the tax bill will be considerably smaller. Still, your beneficiaries will have to pay income taxes as they draw down the traditional retirement accounts you bequeath.

These accounts have become a less attractive inheritance, because in 2019 Congress killed off the so-called stretch IRA, which allowed beneficiaries to draw down these accounts slowly over their lifetime. Instead, beneficiaries now typically have to empty retirement accounts within 10 years.

Under the new rules, spouses who inherit a retirement account can transfer the money into their own IRA, which allows them to postpone taking distributions until age 72. Meanwhile, almost everybody else will want to move the money into an inherited IRA, which they’ll then have to empty within 10 years. Spouses who are under age 59½ and need income right away might also choose this route, because it will allow them to avoid the 10% tax penalty on early withdrawals.

READ THE FULL STORY HERE. Source: Inherited IRAs – HumbleDollar

7 comments

  1. Mr. Quinn:

    I read your last response to my second comment. Let’s start with where we agree ….

    I fully understand that Taxpayers pay for EVERYTHING Government does. I have no objection to that. Nor do I have any objection to paying taxes. That is NOT my point.

    As for Government “scoring” and “accounting”, the estimates I’ve been reading are that Government will realize something close to $16 Billion “over 10 years” in “increased tax revenue” as a result of this 10-year rule. My question is: Compared to WHAT? That claim is bunk! It’s obviously based on static, zero investment growth (within IRA accounts) projections.

    My point is, that this 10-year rule PRECLUDES both my non-spouse heirs AND GOVERNMENT from benefiting from the beyond-10-year INVESTMENT GROWTH that would have been realized under prior law!

    Refer back to my Inherited IRA example in my original post.
    (Note to Commenter Atossa here: Yes. I realize I won’t be affected by this law – as I inherited mom’s IRA prior to Jan 1, 2020. Already got that.)

    Consider that, IF I were to live to the ripe old age of 85, I would have to TAKE and PAY TAXES on the full remaining balance in my 85th year of life anyway even under the prior law. And a majority of it well before my 85th year. See IRS Publication 590-B, Appendix B, Table I.

    My initial “factor” from Table I was 28.7 in 2009. The way inherited IRA RMD’s works is that the beneficiary (me, in this case) divides that “factor” into 1 to get the percentage of the IRA balance that MUST be taken (and taxed) IN THE FIRST RMD YEAR. For me, that was 2010. But that initial “factor” is decreased by 1.0 each year following. Right now, my “factor” for 2019 is 18.7, indicating I have to take (and pay taxes on) 5.35% of the end-of-year balance of the account during the 2020 tax year.

    Next year my RMD “factor” will be 17.7 (5.65%), and the “factor” keeps decreasing by 1.0 for each year. By the time I reach the age of 85, my “factor” will have decreased to 0 and I’ll have to take and pay taxes on the full remaining balance. That is the effect of the “decrease the initial ‘factor’ by 1.0 in each following year, and the implications of the prior law “life expectancy based” RMDs. And that is the basic nature of ALL tax-DEFERRED IRA benefits. Again, I’m good with all of that.

    The thing is though, my 85th birthday is 19 years away. Under this new 10-year rule, I would have had to take ALL of the account balance by this year – and NONE of the next 19 years of investment growth would be available for me, OR TAXABLE for the Government. And that investment growth potential is NOT TRIVIAL. Even a simple SPY type S&P 500 Index proxy has historically yielded an annual growth rate over 8% – and that doesn’t even count the dividend!

    So my question to you and the Government “accountants” – $16 Billion in “NEW” tax revenue, Compared to WHAT? – is basically asking whether the Government “financial geniuses” bothered to even consider the FOREGONE INVESTMENT GAINS! And they quite obviously didn’t!

    I suspect they completely exhausted their entire intellectual capacity in coming up the the “moniker” for this Bill that could be reduced to the “SECURE” acronym. Too funny (pathetic).

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  2. The SECURE Retirement Act [now law that becomes effective Dec 31, 2019] helps retirees by postponing their [dreaded] government mandated Required Minimum Distribution [RMD] to age 72. After all, that is the main purpose of tax-deferred retirement accounts – to help fund one’s own retirement – not to leave a huge tax-deferred legacy to one’s children and grandchildren over their lifetimes [although that has become an important secondary benefit for wealthy retirees.]

    After age 59 1/2, the prudent will continue to take yearly strategic amounts [at a reduced tax rate] out of their traditional tax-deferred IRAs BEFORE they are forced to take larger RMD amounts [at a higher tax rate] by government decree. Many will also slowly convert some of their tax-deferred IRA money into future tax-free Roth IRAs.

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  3. Mr. Quinn:

    I have to say I was surprised at your reaction to this, both with this post and with your comment (“… much ado about nothing or at least little …”) at the linked “Humble Dollar” article. And I thought YOU especially were an advocate of being prudent in such matters.

    The fact is, this elimination of the option for heirs to take their Inherited IRA/401(k) distributions over their lifetimes (and then THEIR heir’s lifetimes) is NOT “little” and it certainly isn’t “nothing”. Especially for the most PRUDENT among us who do provide both for our own retirement, and wish to pass on something for our children’s or grandchildren’s benefit and retirement as well.

    Consider the following …

    Full disclosure – I have an Inherited IRA myself. I and my siblings inherited my Mother’s IRA when she passed in 2009. I was 54 at the time. The value of my inherited portion was just under $7,000 in 2009. Not much, by most standards, and that owing at least partly to the depressed nature of the stock market and financial crisis at the time. But the point is, my Mother was PRUDENT enough during her lifetime to sock away a bit of money into her IRA for her own retirement – which she drew RMD’s from for over 15 years. And during her working lifetime, she never even once made more than $2.00 per hour over minimum wage.

    Zooming forward, over the past 10 years, I have been taking my Required Minimum Distributions (RMD’s) from the account – per IRS rules – and paying taxes on those RMD’s. Two very relevant factors: 1. Over the past 10 years, the basic account has grown to a current value that’s more than twice the value it was when I inherited (about $17,000 now versus under $7,000 then), and 2. That’s AFTER I’ve taken the RMD’s, which themselves add up to MORE than the original $7,000 value of the total account. And I’ve paid taxes on those RMD’s.

    All things equal, I should be able to draw RMD’s (at least) from that Inherited IRA account for at least another 15 years, given my current age and life expectancy – AND PAY TAXES ON THOSE RMD’s for the next 15 years. Additionally, The total account value should GROW at a rate faster than I’m drawing out RMD’s for at least the next 5-7 years. My current draw rate is 5.35%, and typical long-term stock market growth is about 10% annual, including dividends.

    Point being, it’s quite unlikely that I’ll draw even my Inherited IRA, let alone my own traditional IRA, down to zero value over my lifetime, just taking Required Minimum Distributions. But I WILL end up paying MORE total taxes to Government by doing just RMD’s than they would get by compelling me to spend down ALL of the Inherited IRA within ten years!!!

    The Conclusions ….

    This “10 year” rule for bleeding Inherited IRA’s down to 0 value basically PENALIZES PRUDENCE for taxpayers several different ways. BUT, even more comical, it even illustrates the IMPRUDENCE of GOVERNMENT in terms of MINIMIZING LONG-TERM TAX REVENUE!
    Consider that the Government would gain MORE tax revenue long-term if Heirs of IRA’s paid taxes on required distributions PLUS ACCOUNT VALUE GROWTH over 25 to 50 year periods, rather than just 10 years.

    You might want to re-consider your opinion about this, Mr. Quinn. I’d also be interested in hearing what some of your colleagues at SHRM might have to say about it.

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    1. I’m all for prudence and saving as you know, but does that mean taxpayers need subsidize the tax value of IRAs over multiple generations? The surviving spouse is unaffected as it should be, but beyond that I don’t see the need for more than another ten year benefit. The purpose of the IRA is to fund retirement for the individual, not for beneficiaries. You are right that government might get more revenue over time, but you could make that point for RMDs in general if they are not needed by the individual.

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      1. Mr. Quinn:

        To answer the question in your first sentence, there is no “taxpayer subsidy”!

        Traditional IRA and 401(k) account contributions are NOT tax-free, they are merely tax-deferred. And by virtue of the (increasing) RMD – both for contributing workers/retirees AND their heirs – the taxes get paid.

        The point is the Government actually collects LESS tax revenue on those tax-deferred accounts with this new measure than it would have under prior law.

        The only “taxpayer subsidy” are going to be the ones the Government needs to impose on everyone else to make up for the long-term tax revenue lost by denying the long-term investment growth.

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      2. There is the way government scores spending over a ten year period and that’s the reason they did it to get the revenue credit. Deferring the taxes as you correctly note requires more borrowing and interest payments to do so. Everything government does is taxpayer subsidized.

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