Most people rely on their IRAs to fund some or all of their retirement. However, the research shows that the vast majority of individuals will die leaving a great percentage of their IRA behind.
This week, Victor discusses what happens to that IRA and how to put the best planning in place to avoid the trouble and taxes that can come when leaving an IRA from one generation to the next.
Make It Last with Victor Medina is hosted by Victor J. Medina, an estate planning and elder law attorney and Certified Financial Planner™. Through his law firm and independent registered investment advisory company, Victor provides 360º Wealth Protection Strategies for individuals in or nearing retirement.
For more information, visit Medina Law Group or Private Client Capital Group.
Click below to read the full transcript…
Bert: Welcome to “Make It Last,” helping you keep your legal ducks in a row and your nest egg secure, with your host, Victor Medina, an estate planning and elder law attorney and certified financial planner.
Victor J. Medina: Hey, everybody. Welcome back to Make It Last. I’m your host, Victor Medina. I’m so happy that you’re joining us today on our program. We have some great stuff to talk to you about.
Everybody has IRAs and 401(k)s these days instead of pensions, when somebody worked for a company for a long time and then they would give you a pension when you retire. Well, those days are over. More and more folks are relying on the savings that they have in an IRA or a 401(k).
Now, some people have done a very good job of saving money in there, such that there’s probably going to be stuff left over when they die. What happens to that account and how you can transfer it to minimize the tax and trouble? That’s going to be the focus of today’s show. We’re going to cover that in segments two and three.
In segment number one, though, I did want to talk to you a little bit about something that I’m doing in my professional career in terms of getting another designation and why I’ve been surprised by that process.
It’s interesting, if you look at the business card of any financial advisor, they love to tack on initials at the end of whoever they are. They’ll be CFE, F241, whatever it is. They’ve got a long list [laughs] of initials.
In my experience clients are less impressed with that than the advisor is on it. The advisor’s looking for some way to legitimize what they’re doing, and they go out and they get these credentials. There are a white spectrum of how valuable that credential can be. I give you a comparison.
Let’s say I have two credentials right now that I can put on my card. I could put JD and I can put CFP. JD is for my law degree, so if I wanted to sound really impressive about what it is that I was doing I would say, “Victor J Medina, financial advisor” ‑‑ because that’s on the financial company ‑‑ but JD to let you know I went to law school.
I don’t know what that says other then I went to law school and I graduated. It doesn’t say that I’m a practicing lawyer. Many financial advisors who have JDs are not. I happen to be a practicing lawyer, but you’d only know that if you knew about my law office or if you’ve got to know me through the law site for the estate planning and you came talk to us about financial.
They’ve got a law degree. It says, “I got a law degree.” It doesn’t say anything about my ability to practice in the area. There’s nothing about a law degree that says that you’re going to be a good financial advisor. I happen to have spent 15 years or so in the practice of law and most of it in the area of estate planning and elder law planning, so I’ve gotten the tested in the trenches education on it.
The idea, generally, here is that there’s a credential there. The CFP, that’s a pretty good credential because that means that you went through a rigorous set of examination experience and education standards that there putting out there where you’ve got to pass an exam in six areas of core competency. You’ve got to have a bench towards financial planning.
You have to sign on to an ethics agreement about the fact that you’d focusing on planning and acting as a fiduciary, so that’s all pretty good and I got that credential last year. Then there’s a credential all the way on the other side.
This credential, essentially, is like a weekend course, or even less than that, where what you do is you have to sit in a class for about four hours and take an exam. It’s all self‑administered and it’s an open‑book exam, but, at the end of it, you can become…I don’t want denigrate for them, but any of them.
Let’s say that you’re a Certified Senior Living Adviser or something or other. You can get this credential. The general public tends not understand the difference between those credentials and what it takes to get them. We who have gone through that, know that. I went to law school for three years. First of all, I had to graduate and then, after that, I had to pass a bar exam.
I happened to have passed three bar exams with the ability to practice in four jurisdictions. There’s something about that law credential that smacks us some gravitas. It’s chunky because you went to school for three years and then, if you’re practicing law, you’ve passed a bar exam, at least one, and those things aren’t a cakewalk. Same thing for the CFP. That’s a pretty chunky credential.
On the other side, the weekend course, that’s not as rigorous on there. Now, there are websites out there that will actually help you figure out which is which. You can go to, I believe it is, a designation check. If you go to designationcheck.com, what you’re going to be able to do is find a designation and learn about different kinds of credentials, what they mean.
It’ll tell you how long it takes to get it, what kind of examination is there, whether or not there are any continuing education requirements on it. There are about ‑‑ I’m looking at the site now ‑‑ there may be 20 different ones on there. That’s not of all them, by the way. That’s not all the credentials that are out. They just happen to be the ones that are on designation check.
It’s a good way of making sure that there’s something behind it. Anyway, I’ve wasted, now, [laughs] out of this eight‑minute segment, about six minutes or so telling you about the different designations, but not telling you the story that I wanted to tell you. The story that I wanted to tell you is that I’m in the midst of getting another designation, and I was surprised.
We’re focusing ‑‑ and we do focus in our financial area ‑‑ on people who are nearing or in retirement. Specifically, about making sure that we can help them manage the assets that they have set aside ‑‑ their income, their Social Security, fixed income, whatever it is ‑‑ and making sure that they don’t outlast their money. That’s our goal.
I thought, “Well, you know, it’d be helpful to get another designation in the area,” because I’m more interested in the education than the credential. I really haven’t really decided whether or not I would use this credential or not.
I’m in the process of getting it. I signed up for it. Cost about $2,000 to go through the program. It’s three college level classes, and you do it on a self‑study. Then you schedule your exam when you’re ready to go. In this case, I signed up for the program on a Thursday.
As I was taking the pre‑exam, I realized that I knew a lot of this stuff. I ended up scheduling the final for the next Monday. I spent the weekend reviewing the materials. I didn’t pull any all‑nighters. Jeez, I’m too old for that. [laughs] There’s no chance in the world I’m going to be spending all night studying for this.
I thought, “You know, there’s a pretty good chance for me to pass that exam if I just review the materials.” I sat for the exam on Monday, and I passed it. I was surprised about the amount of knowledge that I had already that they were trying to teach me. I think that there’s something to be said for having the experience in an area, and not necessarily relying on the credential to get you there.
There’s two other modules in here. I’m in the midst of the next module. I think I’ll probably take a week of study before I’ll take that exam. My goal is to wrap this up in about 30 days, even though it’s a program that’s meant to go about a year or so. Some people do it in about six months. I’m going to try it even about30 days.
I think I got a good shot of doing that, for the most part because I know this stuff. I would like the credential just to know that I’ve completed that base minimum stuff that they’re looking for. It’ll be an interesting journey for me to have this conversation with clients, and really ask them, “Do you care that I have this credential. Is it important to you?”
We don’t rely on that stuff too much. We’ve got a lot of stake that we sell people. We’re not really relying on the sizzle of having letters after anybody’s name to do that.
Victor: Although we think that some of them are more important than others, like the CFB designation or, in fact, a law degree. Anyway, that’s what I’m up to now. When we come back on the next segment, we’re going to talk about what happens to an IRA when you die. We’re going to talk about, basically, what the IRA is.
Then we’re going to give you some planning options in the third segment about how to make sure that you minimize the trouble in taxes that might be coming down the road. Stick with us. We’ll be right back on Make It Last.
Victor: Hey, everybody. Welcome back to Make It Last. We’re talking today about IRAs and, specifically, what happens to an IRA after you die. When I talk about IRAs, I talk generally about that term to cover all of the pre‑retirement defined contribution accounts that you have. I just got about half of you to roll your eyes in the back of your head because I used too many big words.
Instead of a pension, which we would call defined benefit, more and more companies are offering defined contributions. Defined contributions are you save your own money as opposed to the company putting it aside for you.
Those have taken different forms ‑‑ 401(k), SEP plans, 403(b)s, 457s ‑‑ there are all kinds of numbers around them and they all seem to start with four and they’ve got letters. At the end of the day, that account essentially is money that you have set aside pretax. You set it aside and you got some tax savings for doing so, by the way.
When you put it aside, you got to take that money off of your reported income even though the company gave it to you because you contributed under the rules that they had to an account that would essentially hold it pretax. You got to deduct that, for the most part, off of your taxes. You didn’t pay the taxes on the money that came in.
More importantly, that account has grown over the years that you have been saving and investing in it. Now we’re at a point in time where we need to make some withdrawals off of it. Just as we would expect, the IRS is going to look for their tax money. They’re going to look for that income tax to be paid on any amount that comes out of there.
I have collectively called that an IRA, for the most part because, when we manage the money, we roll it over and we put within an account at Charles Schwab. They’re holding that. We invest it. We tell them what to do with it, but it’s in a traditional IRA.
Now, an IRA can take a couple of different forms. I’ve talked to you about a traditional IRA, but people are also familiar with the Roth IRA. I intend to do a show completely on Roth IRAs, but for purposes of this show, let’s just call Roth IRA the tax‑free account.
That’s the one that you hold and you don’t have to pay any income taxes on it. You have to pay income taxes on the growth and you don’t have to pay income taxes on the distributions that come out.
There’s one special rule about the Roth IRA that’s different from the traditional IRA, which is that you are never required to take any money out of that Roth IRA no matter how old you get. With the traditional IRA, you’ve got to take that money out when you turn 70‑and‑a‑half. We call those RMDs, or Required Minimum Distributions.
That’s basically the federal government saying to you, “We’re not going to let you keep this money tax‑free forever. We require you to spend some of that down,” and every year, there’s a certain percentage that you have to take out. That’s what we call our RMDs.
Now, that traditional IRA will continue on. Some people will exhaust it. They will use all of the money in there, but research has shown more and more that most people will not use the money that’s in there. Why’s that the case? Most people subscribe to some research that was published that says that you can safely withdraw four percent on an annual basis.
That four percent ties nicely and neatly into the RMD schedule because the RMD schedule starts at about 3.65 percent. It goes up annually, but because the account value is sometimes going down for what you take out, the idea is that it’s going to be a level set of distributions, but people will know that you can safely take four percent.
What research has not been very clear about, and what most people don’t understand is that four percent number was based on some math that was a worst case scenario to ensure that people would not run out of money when they die.
What it did was run a number of calculations over and over again trying to get to the number percentage that said, “Look, even if you had the worst part of a 30‑year run on the stock market, you wouldn’t run out of money.” Not a problem, but the way that works out is that most people will not experience the worst 30 years during their retirement.
What ends up happening is that, because performance is better than the worst 30 years, it turns out that there’s actually more money left in the IRA than what they ever took out because their account values over the long haul are growing. They’re growing better than four percent, especially if they’re looking at it over a course of 25 or 30 years.
Largely speaking, there’s more money there leftover, so people need to plan for what will happen to that money when they’re gone. An IRA is an interesting investment account because it’s a contract with a custodian. Most people overlook that. They think it’s their money. They think, “OK, but that’s my account.” It’s actually not your account. You don’t own the account.
That has to do with some federal rules. If you owned the account, the federal rules would say you’d have to pay taxes on the money that’s in there. Instead of you owning the account, the IRA is held by a custodian for your benefit. The account is actually registered with the custodian.
When we opened an IRA, the checks that are made out to Charles Schwab for the benefit of, let’s say, Victor Medina because it’s my IRA account. You’re holding it. You, the custodian, is holding it for my benefit.
Because it’s a contract, basically, the custodian’s saying, “We’re gonna hold that money for you,” it means that the disposition of that money, what happens to it after you die, is governed by the contractual rules that are associated with that account. We call those beneficiary designations.
What that essentially means is that we have designated a beneficiary to receive the value of that account after we die, to be the beneficiary of the account that we have set up. You’re going to do that with the Roth and you’re going to do that with a traditional IRA.
The idea is that after you have you have passed away, the custodian will look at the beneficiary on file and it will pay that money out to them. It’s going to give them some options, which I’m going to talk about in the third segment.
The idea here is to remember that IRAs and Roth IRAs do not go according to your will. Most people are under the impression that everything is going to go through their will. The truth of the matter is that it’s really not.
What will happen is it will go according to your beneficiary. When that beneficiary is listed, the company has to follow those contractual rules. They can’t read anything else into that, just has to follow what’s listed.
Most people will list their spouse if they’re married and then their children if they’ve got them. If not, they’ll find somebody else to be listed as the beneficiary. The absolute worst thing that can happen is to have no beneficiary listed or, in fact, to list essentially your estate. That’s a mistake. You don’t want to list your list your estate as the beneficiary of your IRA account.
It’s important that we know what those beneficiaries are because the way that we name those beneficiaries has a big impact on how we are going to be able to minimize the taxing trouble when we’re gone. Now that you understand a little bit about the IRAs, how they’re set up, what the…
Victor: …field of play is, when we come back on the next segment, what we’re going to do is we’re going to talk about how to structure your IRA so that after you die, you take advantage of the best kind of planning to minimize the amount of taxes that will be owed and the trouble that will occur by making any mistakes along the way.
Stick with us. When we come back at Make it Last, we’re going to talk with you, and give a few tips on how to structure your IRA for the time after you’re gone. Now I’ll be gone, but we’ll be right back.
Victor: Hey, everybody. Welcome back to Make It Last. We’ve been talking about IRAs. What happens to them after you die? We talked in the last segment about the rules about IRAs ‑‑ how they’re set up, how they’re held by custodians.
I finished talking about beneficiary designations and that leads very nicely into a discussion about how to set up these things to make sure that there is the right kind of planning. Remember that the traditional IRA essentially is an account that has never had taxes paid on it.
When you turn 70‑and‑a‑half, the federal government required you to take money out and pay income taxes on that money as if you were earning that as wages. That’s what we call ordinary income. That’s a non‑negotiable. If it was pre‑tax contributions, when it comes out, it gets added to your taxable income.
If you’re interested in learning more about how to proactively plan for your own income taxes, I’m going to urge you to go back to one of our prior episodes. Go onto iTunes on Make It Last. Search for that or go to the website makeitlastradio.com. Search for proactive income tax planning and listen to that episode.
Along the way, money has to come out and you pay taxes on it, but when you die, if there is money that is left over in that IRA, it’s going to pay out to the beneficiary. Here’s why it’s really important to make sure that the beneficiary you’ve designated is the right kind of beneficiary.
You basically have three different options there. You’ve got a charity, you have a natural person, or you have an entity. A non‑natural person entity might be your estate or, in many kinds of our planning, a trust. We use trusts a lot in our planning.
Our trusts are a little bit different than most trusts. In our trusts, we make sure that we’ve written it that the IRS will look at the trust and actually call the trust an individual for tax purposes, and that’s important. When you leave it to charity, all the income tax is tax‑free.
You want to leave it all to a charity? That’s fine, but most of my clients don’t want to do that. Most of my clients want to leave it to a particular person, typically children or a spouse. When we name it to one of those individuals, we get some preferential tax treatment.
We’ve got one of the trusts that we write that looks like a person. We actually name it as a person. We’re going to get some preferential tax treatments. The kind of tax treatment we get and the options that we have depend on who that person is to us. If we have a spouse named, we’ll have the option to do one of two things.
The first is, we can keep that account registered in the person who has died, in their name. Essentially, we can leave it there and continue to take distributions out of that account according to that person’s life expectancy.
You might have gotten turned around in that, but the idea here is that, if your spouse was younger than you, it might be worthwhile to leave that account as is because the size of the distributions is going to be smaller. Smaller because they are younger than you.
If, in fact, you died and your spouse was younger, they’re going to have the option to roll that into their own account. We’re going to call that a spousal rollover. The benefit of doing that as they gets to treat the account as if they were their own. Now, let’s take our hypothetical family.
We had a husband, died at 75 taking, distributions and their spouse was 65 years old, younger than the required minimum distributions. By rolling that account over, we got to stop the RMDs and essentially wait another five years before we have to take another distribution before it’s forced out.
Spousal rollover is pretty powerful and only the spouse ‑‑ only the spouse ‑‑ gets to roll that over and treat it that way. We don’t get any more opportunity to do that. You don’t have the opportunity to leave it to a child and allow them to roll it over. If you leave it to your children, what it becomes to them is an inherited IRA. That’s a term of art, inherited IRA.
The inherited IRA is essentially the ability for that child to then stretch out the taxes that would be owed on the distribution by only taking the life expectancy distributions that have to come out. Here’s what I want you to think about. The children have their own RMD schedule.
They don’t get to delay it till they’re 70‑and‑a‑half. When they receive it as an inherited IRA, they must take a percentage out every year. There’s a whole schedule that is set to that, but they only have to take that percentage out. They don’t have to take the entire amount.
What that allows them to do is continue to invest in that account so that it grows faster than the distributions that come out. Distributions that might be owed on, let’s say, a four‑year‑old might only be about, I don’t know, two percent or so, two‑and‑a‑half percent.
If I have an account that’s growing in five or seven percent, especially over the long haul, that two percent distribution means that there’s going to be more a lot more money accumulating in the account than out of the account. That is a way of stretching the IRA.
You can only stretch the IRA if you’ve named an individual. If you have named your estate as the IRA beneficiary, then what will happen is that you’ll have to take all that money out, no matter where it’s going, no matter who it’s going to.
It can end up going to children, but you’ve got to take it out and then essentially pay the taxes over five years. It’s as though you realize, “Oh, $500,000 as income in one year.” Imagine the taxes that are owed on that. You’re at the highest bracket on $500,000. This is why it’s really important to make sure that those beneficiary designations are correctly set up.
The result that we want is we want the ability to stretch it out. We want to preserve that stretch out. By the way, that’s stretch out is the same whether it’s a Roth or a traditional. With a Roth IRA, when it becomes inherited, you still have to take those distributions.
Remember, I said when it’s your Roth, you don’t have to take any distributions out, but when you leave it as an inherited Roth IRA, you do have to take distributions out of there and those distributions are tax‑free.
What’s nice is that if you’re able to stretch that out, you’ve got tax‑free growth for 20 or 30 years. If you messed up the beneficiary designations, the money’s not taxable, but then the growth on it is because you have to take that all out within the five‑year period.
It’s really important to make sure that we’re able to stretch that out. There’s one more element I want to hit before we wrap up, which is that many of my clients, who are wonderful people, [laughs] have children who are maybe not so wonderful.
What they’re worried about is making sure that the children don’t blow all of this money. If I leave it to them directly, if I leave them that money directly, yeah, they only have to take the required life expectancy distributions, their own RMDs, but they could take it all. It’s found money to the kids.
What will happen? “Well, I don’t care what the taxes are. I want that money in my pocket. I’ll pay the taxes and get what’s leftover. You say I got 60 percent left? That’s 60 percent more than I had. If it’s going to be at a 40 percent tax rate, I’ll take all of that right ahead of time.” That’s why it’s important to make sure that those accounts are properly titled to be owned by a trust.
Inside of a trust, what you’re going to be able to do is keep it sometimes protected from them. You might put somebody else in charge of the trust. Protect the child from themselves. Protect it from divorce and creditors. If I keep it inside of a trust and I don’t allow it to all come out, I might be able to protect that from a divorce sometime in the future.
There’s a recent case law that basically said an inherited IRA is not protected from creditors, but if I leave it in a trust it is. It becomes very important to have trust. Here is your marching orders before we wrap up for today. Review your beneficiary designations and check to make sure one of two things is the case.
First, that that it is properly titled. If you’re married, put the spouse first. If you have children, make sure the children are listed as the contingent and that you don’t have anything in there that says, “To my estate or according to my will.” Just name the people that are in there. That’s the baby steps.
The PhD level planning. If you really care about this, get it to be in front of an estate planning attorney who knows what they’re doing and creating trusts for your benefit so that when you leave that inherited IRA to the next generation, you’re able to leave it protected.
You got to be with a good estate planning attorney to do that and your financial person needs to know how to title it the right way too. There’s some value if you can have them under one house, but definitely review those things to make sure that everything will work after you’re gone and that you will minimize the taxes and troubles that might come with an IRA after you’re gone.
All right, so we’ve covered a lot today. Thanks so much for joining us. This has been Make It Last. Listen, if you like the show, please go onto iTunes and rate it highly for me because that way other people that are searching for the best podcast and radio show on retirement matters will find Make It Last, and they will be as joyful as you are having listened to this program.
If you have any questions for us, send them to email@example.com. Otherwise, we will catch you next Saturday on some other topic that will be equally as fascinating for you in your life as you near or enter retirement. This is Make It Last, helping you keep your legal ducks in a row and your financial nest egg secure. Catch you next Saturday.
Bert: The foregoing content reflects the opinions of Medina Law Group, LLC and Private Client Capital Group, LLC, and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment or legal advice, or a recommendation regarding the purchase or a sale of any security, or to follow any legal strategy.
There is no guarantee that the strategies, statements, opinions, or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. Indices are not available for direct investment.
Any investor who attempts to mimic the performance of an index would incur fees and expenses, which would reduce returns. All investing involves risk, including the potential for loss of principal. There’s no guarantee that any investment plan or strategy will be successful. We recommend that you consult with a professional dedicated to your needs.
Podcast: Play in new window | Download
In case you were not aware, your RSS feed setup for the podcast and the iTunes listing do not allow a new user to get a complete listing of the podcast? When I looked to catch-up on the podcast using the RSS feed in Overcast, I could only go back to episode 14.
Thank you for sharing your knowledge.
All the best,
Thanks for the heads up. I’m going to contact the IT department to try and correct that now. I’ll post here if I find the issue and I’m able to correct.
Unfortunately, I AM the IT department…
Thanks for listening and for your interest.
I’ve updated some settings to now list 300 episodes (even though we’ve only published 21 or so), so that should help. Let me know if it doesn’t fix itself on the next couple of re-freshes.