IRAs are very different from most other assets and require very specific planning. IRA’s tend to be where most people’s money is – so tune in this week to get a clearer picture of just how different IRAs are from your other assets.
Make It Last with Victor Medina is hosted by Victor J. Medina, an estate planning and Certified Elder Law Attorney (CELA®) and Certified Financial Planner™ professional (CFP). Through his law firm and independent registered investment advisory company, Victor provides 360º Wealth Protection Strategies for individuals in or nearing retirement.
Click below for the full transcription
Victor Medina: Everybody, welcome back to Make It Last. I’m your host, Victor Medina. I’m so glad you could join us this Saturday morning. I’m excited to be here because we’ve got a great show taking a different direction from where we were last week.
We had a great show last week and if you missed it, you missed the opportunity to learn a little more about CareOne Jackson and some of the activities that it’s doing in its Harmony Village. I urge you to go back to the podcast either on Spotify or on iTunes, look up that episode and learn a little bit more about some of the innovative things that they’re doing at assisted living facilities.
We’re in Assisted Living Week. We’re ending it this September 15th, if you’re listening live. That was celebration of assisted living. I wanted to pivot a little bit today and talk to you about 19 different ways that IRAs are different from other assets.
We’re going to go through each one of those and explain a little bit more about what makes what I’m sharing with you so different from other assets. I’m looking forward to doing that.
Before I get into it, I do want to share a little bit of personal information. I think it’s related to something you want to hear about, especially in retirement. We had an opportunity to gather my entire family. By family, I mean my parents, my mom, my step‑dad, my brother and sister, their children. We had three children, six grandchildren, my parents.
We were all in Charleston, South Carolina. We were trying to ‑‑ with the storm, just thinking so much about it. We were trying to get my mom’s home ready for downsizing. We were trying to get ourselves all around the stuff that had to be packed, the stuff that could be shipped to their place in New York, what needed to maybe get sold in a tag sale. Interesting dynamics developed around that.
We were going through everything that were in cabinets, in drawers. It was really helpful to have the family members together, because we got the opportunity to hear from my mom’s stories about what she had. There were some stuff that were just run‑of‑the‑mill and who wants this dish and whatever else.
There was obviously some other things there that had stories behind it. My mom still kept, for instance, a set of tin templates for making cookies. She always had some activities. She was card making. She was making cookies and different decorations.
We got an opportunity to relive some of that stuff which I think it helps me highlight how important it was to make sure that we’re passing on our values and our stories in addition to our money.
So much time is spent on making sure all the concrete and cold‑related aspects of planning room place. Do you have the right documents? Do you have the right money? Is it supposed to go where it is, optimizing taxes?
At the end of the day as we were gathering around the stuff, I was reminded of how unimportant that stuff really is. That the really important stuff that we were focusing on were the stories and values in the memories that were being passed on.
Certainly it was good that we went through some of this ahead of time because it will save us having to go through it later. We each grab some things that she wasn’t going to be able to take on to the next home and get an opportunity to go through old photographs.
There is good work that was done in doing this ahead of time. Even though we got some clarity about who was going to be getting what and where stuff was going to be going, I think I was really just more struck about the idea that in the act of going through the stuff and sharing all of this journey as she’s downsizing what was in there with us.
We really got an opportunity to pass on those values as well. I think we too often overlook that or we get to a point where that’s too late. It happens too far removed from our chance to really enjoy and reflect on it. That was a really good trip.
I was reminded of the reason why the three kids do not live still together. [laughs] It’s good to be with family and it’s good to go home. We had some big parties together for eight straight days of people together. While we were there it certainly was rewarding.
Little quick lesson on that, I didn’t want to go right into today’s’ topic because there are 19 things that make IRAs different. Reason why I wanted to focus on this is because IRAs tends to be where the money is. Right?
We’ve moved away from predefined benefit, plans like pensions where people could rely on their employer to provide their income and retirement, and right at point in time where we have been saving our own money.
That’s how retirement is enlarging in IRAs because of the tax‑deferred nature of it. We were incentivized to put money aside because we wouldn’t be taxed on it as income if we did. Then we would be using this when it came back out in our retirement. These were basically 30 years in the making, I would say. It’s about 30 years.
What’s interesting is there are over maybe 70 million baby boomers. They are the largest percentage of people that have, or rather the other way around, they have, by the largest percentage IRAs as what comprises their money and their retirement.
To fast forward for when these rules were originally made, 30 years ago to today and down much as different, the IRA distribution rules specifically on taxation, while they’re known as crazy as they once were, are still pre‑challenging for even the most sophisticated advisers, CPAs, attorneys, and obviously, for clients as well.
I know that in the news there’s been some noise being made about President Trump essentially proposing some rules to change some of the rules around IRAs, and when you had to take distributions. We don’t know yet if there is going to take hold. Obviously, if they do, that’ll be information that we’ll share with you at that time.
It’s just important, I think, that just as important that even before the rules change, we can understand where these things are because some of the stuff that makes IRAs different aren’t going to go anywhere, even with this new set of rules.
The reason why it’s really essential for advisers, people who help with retirement planning to help clients accumulate, grow their retirement and get that money out efficiently is because it’s what you keep after taxes that counts. That’s where these IRA and plan distribution rules come in.
The more you keep, the better job I think your adviser is doing. It’s one of the reasons why we have a chapter in the book that I wrote, “Make It Last ‑‑ Ensuring Your Nest Egg Is Around As Long As You Are.” That book has a dedicated chapter just to proactive income tax planning because the tax is the biggest bite of what comes out of your retirement.
Victor: I think it’s important to go through these. What I’m going to do is I’m just coming up on a break right now. Let me take the break. When we come back, we’ll jump right into the 19 things. This is a good opportunity, even though the commercial is going to be talking about me and my firm. [laughs] It’s a good opportunity. Ignore that.
Go get a pad and pen, and when you come back, we’ll go through all 19 of these things. Strap in, get your coffee ready. We’ll be right back after this break.
Victor: Hi, everybody. Welcome back to Make It Last. Today, we’re going to be talking about IRAs and the 19 things that make these asset classes, these investment homes…what makes them so different. Trust me that we’re going to go through 19, we’re going to go through them pretty quickly.
The break was your opportunity to get pad and paper. You’ve been warned, and now we’re going. The first thing I want to share with is, estate planning is different for IRAs because IRAs are distributed differently than all other assets, both during life and after you pass away. IRAs are beneficiary designation assets.
They’re not going to pass through probate. They’re not even going to pass based on being owned by a trust. In fact, they can’t be owned by a trust. They’re going to require slightly different planning in order to incorporate them as a cohesive plan for your estate plan.
For instance, what I mean by that is that, if you’re going to create a revocable living trust is the basis of your estate planning, which is something that we recommend, you’re going to need to incorporate the IRA by leaving it as a beneficiary named in the trust as a beneficiary so that money can flow through there.
Second thing is that IRAs pass by contract, and they’re outside of a will. This is a big point when I share this information with other people, like in seminars, because what ends up happening is that people believe that their will is going to govern all of their assets, when in fact, it doesn’t. It doesn’t apply to assets like your IRA, because it’s an asset that is a contract.
That means that the contractual terms govern where this stuff goes. In this case, we’re talking about a beneficiary designation that tells the custodian who’s holding your money in the IRA where to pay it out. Next, IRAs have required minimum distributions. When you turn 70 and a half, you have to start taking a minimum amount out. There are no other asset classes that are forced out like that.
It’s not like when you own a home that after you turn 85, you need to start distributing some of the money or selling off some of the pieces. If you’ve got an after‑tax investment account, you can just hold those investments forever, and never sell or share any of them. These required minimum distributions make it different from other asset categories.
Now, they also have a set of a complex distribution rules during life and death. For instance, when you take money out, you get taxed on 100 percent of that money as though it was all income. You’re able to take a portion of it out, let’s say when somebody dies, there are rules about how much you have to take out as your core required minimum distribution.
Even though your age is probably younger than your parent’s age, when you inherit it, you still in that first year have to take out what they had to take out in that year. You probably feel a little confused on that, right? I feel confused even describing it, too.
You get to see just one subset of distribution rules that affect the straddle between when somebody is living when they pass away. It makes it difficult if you don’t know that ahead of time. It leads to the next fact which is IRA distributions can incur very costly penalties.
The two different penalties that it can incur that most people know about is that, if you fail to take out your required minimum distributions during your life, you’ll be taxed or penalized about 50 percent of that money as penalty. The way that works is if you were supposed to take out it’s a $2,000 last year and you didn’t, your penalty’s $1,000.
That 50 percent penalty is something that is no joke when it comes out. Being the fact that you just lost half of that money, and by the way, that was your penalty that was an after‑tax penalty. It wasn’t a pre‑tax penalty. What I’m saying here, like that $2,000 needed to be taxed.
You weren’t going to put $2,000 in your pocket, you were going to put, let’s say your tax rate’s like a third, two‑thirds of that money in there. You’re going to put maybe $1,300. On top of that you owe a penalty of $1,000, so you really only ended up with $300 of that. You see the way that works, very costly.
The other one that’s a costly penalty is if you want to remove money from the IRA prior to being 59.5. If you end up trying to take money out, there are some hardship rules in which you can escape the penalty, but for the most part, if you just need access to that, again, like you contribute it, and then you want it back out, there’s a 10 percent penalty if you take that money out prior to 59.5.
IRAs are highly taxed upon death or withdrawal. When you start to take that money out, 100 percent of that is taxed as your income. This makes sense because you are never taxed on that money when it was originally contributed. But in this case, when it comes out with you because you need very close to the same money to be living even in retirement.
It turns out that your effective tax rate and retirements pretty close to your tax rate when you are working, I mean, you don’t have as much because you’re saving some of that. You have a little bit less, but you’re pretty close to the same tax bracket. There’s not a tremendous amount of savings in there. Next IRAs do not receive a step‑up in basis.
They’re almost subject to double taxation at death. If you are in a state with a state or an inheritance tax, then the full value of what is that in that account is countable towards your taxes. If the account statement says $600,000, that amount is added to the calculation of estate inheritance tax, but the double taxation comes in.
As we were just saying, that’s not really your money. You haven’t paid income taxes on that. They’re going to apply income taxes on top of it, and there’s no basis adjustment. It’s not like if you contributed 100,000, and it grew to 600,000. Then when you leave it to the next generation, it says though, there’s no tax because it got stepped up to the value of death.
No, you still owe it not just on the game, but all $600,000 that’s in there making it one of the more highly taxed assets as well as subjects to double taxation. Investment gains, as I was saying, or tax that ordinary income rates and not capital gains rates. You had this IRA for many, many years, probably dozens and dozens of years.
However, you did not, it because it’s in an IRA, you do not get the benefit of long‑term capital gains. When you take this money out, every dollar of that is part of your ordinary income calculation. Instead of paying capital gains rates at like 15 percent, you might be paying at a 22, 25, 28 percent is higher tax brackets.
Next, IRAs cannot be transferred or gifted during your lifetime like most other assets, and so this restricts the planning opportunities for couples and families. I cannot, for instance, give some of this money from my husband to my wife. In my planning scenario, try to equalize the estate. I can’t take a portion of the IRA and even in a tax‑deferred status. pass it on to the kids.
That’s important because even if I was willing to defer the income taxes and then just pay it on their rate, I can’t make a transfer of that value in the same way that I could give, for instance, a home or a CD or a bond. I can’t just give that over an IRA, and that makes it really different. All right, we’ve had a bunch. Let’s take a quick break.
When we come back, we’re going to look through the rest of the list. This is a good opportunity for you to catch a quick restroom break. Get some more coffee in you. I’m going to be talking this quickly about the remaining ones in there. We’ll be right back on Make it Last.
Victor: I wanted to follow along, I’m sorry, back from the break. I wanted to follow up on what we were talking about before the break, about not being able to be gifted. You can’t change the owner of this stuff.
When you establish the IRA, the owner that you have over that is the owner that remains with that until they die. I suppose you could change it, but it would trigger an immediate incomplete distribution of all of the money that’s in there. It would 100 percent be taxable as income. You would lose the ability to grow the account tax deferred.
Speaking of ownership, IRAs can’t be jointly owned, like other property can, even in community property states where everything is deemed to be conjoined together, like in Texas, or California, you cannot co‑own or join an IRA.
I’ll tell you quickly, as an aside, one of our planning techniques around this is many times people are looking at a percentage of their IRA to pay out as income in retirement. We talked about the need for a floor in your retirement income planning. A guaranteed bottom where you know that that meets your needs.
If we were to set up a payment out of the IRA directly, we could do that for so long as one person was alive, the IRA owner. After that was the case is very difficult to continue that on. The IRA would have to transfer to somebody else.
We do have a planning product in the insurance world, a form of an annuity that can be joint, that can be paid out over two lifetimes. It gives us the opportunity to continue to roll that over as a spouse. If we’re creating a floor for somebody, and we just did this plan for somebody that was retiring, where there was an age differential.
We basically set up an income annuity that would help them make sure that they had a guaranteed floor if they needed it, and it would continue on for both of their lifetimes. It’s really, really strong product in that. Anyway, as I was saying, the IRAs cannot be jointly owned.
The next point is that the choice of an IRA beneficiary will ultimately determine the future potential value of that IRA to other beneficiaries. That sounds like some crazy stuff. What do I mean by that? What I mean is that when you leave an IRA to the next generation, they have the opportunity to stretch that out over their lifetime.
Their lifetime is a predetermined number in the IRA rules. Based on their age, they’ve got a life expectancy ‑‑ who knows if they actually live that long ‑‑ but they’ve got a life expectancy already in the numbers.
If we choose an IRA beneficiary that is considerably younger than another beneficiary option on there, we’re going to get a longer stretch out, because it’s going to force a smaller amount of money out of the IRA every year. Those required minimum distributions have to continue to get paid out every year, even if you leave it as an inherited IRA.
It’s just that that percentage shrinks, the younger you are, the smaller it comes out. Imagine a scenario where you’ve got grandparents that want to leave money behind. They have a choice, they can leave it to their children, but their children don’t really need it. They’re pretty close to retirement themselves. Maybe they’ll leave it to the grandchildren.
If they leave it to their grandchildren, the stretch‑out is going to be for much longer. They’re able to continue to defer the payout of that money so that it grows tax deferred for a longer period of time. I hope I’m making sense. Next, you can use a trust as an IRA beneficiary, but you have to use a specific one with specific provisions in there so that they qualify as individual beneficiaries.
What I mean to say about that is there no special rules for trusts name as IRA beneficiaries within the account. What you do is you name the trust, and then hopefully, you’ve got the trust with the right rules to get the deferred tax treatment.
It’s really important that you’re working with somebody that just not only understands how to create a generic estate plan, but understands how to incorporate money into the estate plan, like we’re talking about here.
It will give you the benefit of using the trust as an asset protection vehicle as something that leaves money protected from divorce and creditors when somebody dies, while also simultaneously getting the stretch out of that money over the rest of their lifetime.
The next thing, as it comes into trust, by the way, is the IRAs don’t have a concept of the difference between principal and income. The entire IRA, principal and income can be distributed into an income beneficiary of a trust, basically, leaving nothing behind for the next generation.
Sometimes people will say to me, “Well, look, I want to leave my IRA to this individual. I want them just to get the income from that. I want the balance to go, let’s see, to my grandkids after that person dies.” You can’t do that with an IRA, the entire amount can be distributed, leaving nothing. I can’t carve it up into the difference between principal and income with an IRA.
The last one that I want to spend some time on, full disclosure, I got through all 19, but we’re running up at the end of the show. We have more to summarize everything. One of things I want to talk about is that, many times, IRAs need their own separate estate plan.
That can sound a little weird, because you work with an estate planning attorney. You figure, “OK, well, I have an estate plan, and it’s a bucket, like a trust and just throw everything in there and move on.” That’s not really how you would handle an IRA.
An IRA needs its own separate plan in order to really optimize what you can do with it. You need to think about the beneficiaries and the tax treatment. You need to think about, for instance, proactively moving money out of the IRA to lock in a particular tax rate. That planning strategy is basically using maybe a lower tax bracket of a retiree.
You’re retired, and you don’t have a lot of wage income, but your kids and the next generation as beneficiaries, they’re working and they still have a lot of money coming in as income. If they inherited your IRA, they would still need to take money out, and it would be taxed at a higher rate. Their rate, not your rate, which is the lower rate.
If you proactively move some money out of that, you proactively end up shifting money out of the account. What you end up with is a lock‑in of that particular tax on those funds. For instance, if you take it out at your 12 percent bracket, you’ve locked in the taxes on that money that get converted at 12 percent.
When you get it invested going forward, you can get capital gains treatment on any anything that grows later. Not only that, you can get a step‑up in basis. We’re going to raise all of the gain in that after‑tax account.
What you’re seeing right there in that mini discussion is the benefit of having a separate little plan even over the IRA making sure that we’re thinking about that in a very strategic way in order to make sure that we optimize it.
If you don’t need your distributions out of an IRA, it might be worthwhile contributing them into a life insurance plan in order to leave more tax‑free assets behind when you die.
There’s all different ways to incorporate the IRA, but IRA planning, specifically how to do planning around that, is almost a super specialty even within retirement planning, to make sure that you’re really optimizing the rules to your benefit.
Now, we get to that recommendation that you always hear from me, which is, you need to be working with a qualified professional in order to do that. Not only we’re looking at an estate planning attorney, likely with some retirement planning expertise. Even with the retirement planning expertise, you start with a CFP designation.
You look at a retirement specific designation, like the one I have is an RICP, but there’s the RMA, there’s a CSRC. You look for something that’s specifically in retirement. On top of that, you want to make sure that they are working with strategies that, from a fiduciary standpoint, they’re all on the table.
You work with somebody that is…a fiduciary looking out for your best interest, and really trying to make sure that you’ve got all of those bases covered when you’re planning around your IRA. That’s how you’re going to get the best advice when it comes to distributing that money in the future.
I hope that this has been helpful for you. IRA is a very special asset. I want you to be thinking about it deliberately, and really working with somebody that is going to be on the same page as you, when it comes to this retirement planning.
Before I close for today, we actually have a couple of upcoming guests I want to tease, that I’m really excited about. Next week, we’re going to be talking to a really qualified geriatric care manager about what to do when somebody needs care in the home and how you can use a geriatric care manager in your life to help that older adult.
The week after that, I’m going to be talking with a Medicare specialist, somebody that works with individuals in claiming strategies for Medicare, working with their plan D and prescription benefits.
We are coming up on the open enrolment season in the middle of October. She’s also going to talk to you about Medigap and Medicare Supplement policies that are subject to change. She’ll help you with those as well.
You do not want to miss the upcoming shows. If you’re not going to be around on Saturday morning live on 14:50 AM, you definitely want to subscribe to this on iTunes or go over to Spotify and make sure that you’ve got this bookmarked so that you can catch those upcoming shows as well.
Victor: This has been Make It Last where we help you keep your legal ducks in a row and your financial nest egg secure. We will catch you next Saturday. Bye‑bye.