A gentleman in his late 60s came to see me recently and told me that his beloved father had left him an IRA worth just over $1 million.
He told me how he already had filled out the forms to withdraw the money and use it to pay off his house, take a trip and give some money to his own kids and grandkids. And then, he wanted help investing the rest of the money for his own retirement.
I asked him a question that caught him by surprise: “Did you budget for the $400,000 in taxes you just triggered by taking a lump sum withdrawal of the entire account?”
Sadly, he had not realized that the IRA withdrawal was taxable income. I had to tell him that the IRS doesn’t allow us to “un-ring” the bell, put the money back and draw it out more slowly instead. There are no do-overs with inherited IRAs.
I can see the potential for new tax mishaps under the SECURE Act that was enacted in 2019, which now requires beneficiaries to empty the inherited IRA account by the end of 10th year following the year of death. Within that 10-year period, there is total flexibility — withdraw it all or withdraw none.
I fear that the years might blur and heirs inadvertently lose track of how long it’s been and accidentally miss the deadline. Because if they empty the account on the first day of the 11th year, there is a 50 percent penalty on the late withdrawal PLUS income tax owed.
A $1 million IRA would have a $500,000 penalty and a $400,000 income tax bill, leaving the heirs with $100,000. Crazy, isn’t it?
On the plus side, the 10-year period is a great tax planning opportunity, allowing an heir to take large distributions in some years and none in others, using the flexibility allowed within that time period to their advantage, minimizing the amount of tax ultimately paid.
The SECURE Act has raised the urgency of tax planning and ongoing advice. First, IRA account owners need their named beneficiary designations set up correctly to give heirs the option of the 10-year window; and second, the heirs need professional ongoing advice to minimize their tax bill and avoid needless penalties.
Navigating the nuances of inherited IRAs is not for the faint of heart — and there are no do-overs.
Yovonne Marsh is a financial advisor whose columns appear regularly in the Business section of farragutpress.
Financial Planning & Investment Advisory Services are offered through Marsh Wealth Management, LLC (“MWM”), an independent investment advisor registered with the state of Tennessee. Marsh is an investment advisor representative of MWM in Tennessee.
Marsh Professional Group, LLC, is a Tennessee registered public accounting firm and a separate legal entity from MWM.
For a detailed discussion of MWM and its investment advisory fees, see the firm’s Form ADV on file with the SEC at www.adviserinfo.sec.gov.