EP 13 – What Happens to an IRA or 401k when the owner dies?

This week on the Directed IRA Podcast make sure to join mark and mat as they discuss all the variables for the best tax, legal, and family planning situation when it comes to inheriting an IRA or 401k. New rules went into effect recently on your options when inheriting an IRA or 401k.

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Mark Kohler: Welcome, everybody, to this week’s episode of the directed IRA podcast, your source for authoritative, interesting, strategic, IRA, 401(k), everything self-directed planning. Wow, that sounded good.

Mat Sorensen: That did sound good, let’s just record that and we’ll just start every episode like that. Authoritative, I like that. I don’t know why, but I thought it’s like a WWE or a wrestler like body slamming someone and they’re like with authority. That’s that’s what came to mind.

Mark Kohler: We should have had some music in the background. We’ll have to work on that. Well, anyway, welcome. Yeah. My name is Mark Kohler. I’m a tax lawyer and small business adviser, just an entrepreneur at heart. Loving the American Dream in Main Street America. And I’m here with my illustrious another good adjective, Mat Sorensen, who is the author of the directed IRA Handbook, the best selling book in America on how to self-direct your retirement account and control your future. Man, we just need a frickin record me today.

Mat Sorensen: Did you take some like lessons or something, what’s going on?

Mark Kohler: He pulled that out of his butt, that’s definitely.

Mat Sorensen: Yeah, You’re making it sound really cool today for the podcast. But we’re grateful you’re here. And we’ve got a lot of prior episodes, of course, on what is Self-directing and all those topics we want to focus on. On an important item, though, the inherited IRA sometimes called a beneficiary IRA. A lot of people self-direct these accounts. I mean, with retirement accounts being around since the 70s, these are now starting to pass on to the next generation. And so we’re deeing more of these accounts.

Mark Kohler: Yeah, but it’s also sometimes called the Holy Grail of IRA accounts. Hmm.

Mat Sorensen: Yeah, it is. And you go through some of these reasons on why this is the thing. Like if you’re, you know, parents, whoever it is, passed away and you’re hoping for some asset to inherit. Let me tell you the one thing you want to get. If you get one hundred thousand dollars in gold, one hundred thousand dollars in a checking account, one hundred thousand dollars from life insurance proceeds. One hundred thousand dollars in a Roth IRA, those assets are not equal. I know they’re all one hundred thousand dollars. And you’re thinking, well, what’s the difference? Trust me, the Roth IRA. Listen, we’ll tell you why you want that asset over anything.

Mark Kohler: Ok, so that means you do not share this podcast with your siblings, although we want you to share this podcast everywhere you can. This would be the one that you want to keep in your back pocket, because when you’re at the poker table, You know, that didn’t sound good Mat right? I mean, we’ve got to give a disclaimer here.

Mat Sorensen:  Yeah, the poker table, that’s a little you know, let’s just say when you’re at the dining table, you know, discussing the options, it’s a somber day.

Mark Kohler: It is and and I will on a on a good note, I mean, on a professional sensitive note, we should have given this disclaimer initially when we’re talking about death and inherited assets, in particular today, the IRA or the 401k. Please know that we’re trying to just make this topic palatable. It’s no fun talking about death. And we know some of you may have had some family members or friends especially affected by Covid this year and passed away or just normal wear and tear or some crazy accident. But we just want to say be patient with us. We’re going to make this as enjoyable as we can, which might involve some puns or jokes about dying. Hey, we’re all going to die. Ok, how was that, was that OK?

Mat Sorensen: And that’s that’s true, we will we will all die. So we just want to talk about what happens to your retirement account. So let me say one other thing, though. This is important for those that are self-directing, because we’re going to walk through the options here in a second. The one thing you have to keep in mind, if you’re self-directing an inherited IRA, you have to be careful because you do need some liquidity at a certain point. We’re going to go through that. But I just want to say that as you’re thinking about Self-directing an inherited IRA. There’s some timing rules here where eventually that asset needs to be sold so you can get the cash to then distribute it out. We’ll go over that here in a moment. But I want to say that it does take a little more planning for Self-directed accounts than others, but it’s still very doable, very easy. Lots of our clients are doing using inherited IRAs to Self-direct.

Mark Kohler: And I and I, I’ve got some other news or some fun items that are unrelated to this, we will come back to that later. But I would suggest this be our approach to the topic. Tell me if you Mat’s the sexpert, so I’m going to throw this out. Why don’t we talk about Inheriting a retirement account if you’re a spouse?

Mat Sorensen: Yep.

Mark Kohler: And inheriting a retirement account if you’re not. And out there are shows 50/50. We got a lot of single folks, a lot of married folks don’t feel picked on. Maybe we should flip a coin which one we go with because some people feel like we’re chauvinistic in one particular way or another. Now, currently I’m married Mat’s not, so we can, you know.

Mat Sorensen: We can work that angle. OK,

Mark Kohler: One of the single ones not. So anyway. I was going to make another comment that would not be appropriate.

Mat Sorensen: Yeah.

Mark Kohler: My wife on the show, so I’m not going to say anything. But anyway, So. Well I will throw this out. But we want to talk about 401(k)s. IRAs, Roth, all types of retirement accounts under those two categories. So Mat, what do you want to do? First, single or married.

Mat Sorensen: Let’s do the spouse, let’s do the spouse first, it’s a little easier. So when your spouse passes away, let’s say you’re the surviving spouse here. All right. Your first option is to do what’s called a spousal rollover. Now, this is not an inherited IRA or sometimes called the beneficiary IRA. This is becomes your IRA. So let’s say, you know. Your spouse passes away, they had an IRA or 401K in their name, it was their account. What happens is you can transfer that account over into your IRA in your name. If you already have, let’s say, a traditional IRA and your spouse passed away and they had a traditional IRA, you can just transfer that those assets over into your IRA. And so it’s treated like it’s just your IRA. Now, that is unique for spouses, everyone else. You can’t do that. This is a unique option for spouses. That’s really beneficial because now it’s just under the regular retirement account rules for you in your age. And when do you turn fifty nine and a half or 72.

Mark Kohler: Now, what about an Ex-spouse, because there’s some Social Security benefits for an ex spouse if they were married so long, does it is there any factor of the ex husband, ex Wife?

Mat Sorensen: Nothing there. I don’t think they’ll be in Category two if you were crazy enough to leave your retirement account to your ex-spouse or not. I don’t know. I’ve had many clients in the Self-direct space in particular that are former spouses divorced that still are in deals together and still continue to it’s whatever Ok.

Mark Kohler: Or they forget to amend their beneficiaries’ people. If you’ve been divorced or your spouse passed away and you’re thinking about getting remarried or whatever, I mean anyway, if you’re not married anymore, you might need to go in and update your beneficiaries. But topic for a separate podcast.

Mat Sorensen: That’s how your retirement account passes. Keep in mind it’s not your will, it’s not your trust. Your retirement account passes based on your beneficiary designation. So if you list your spouse first that’s what we’re talking about here, it’s going to go to your spouse, of course, and they can do this spousal rollover. Now, they could take a lump sum if they want. So if your surviving spouse and let’s say it’s one hundred thousand dollar IRA, you could say, no, I don’t want to roll it over. I just want all the cash. And maybe you’re maybe you’re 50. You’re not fifty nine and a half yet. So if you rolled the money over to a spousal rollover fifty nine 1/2, you’re not gonna be able starting your 50. You have to wait nine and a half years before you can take distributions because it follows your retirement account rules. But let’s say it’s again, spouse passes away. You’re 50 and you need the money. You would want to maybe take a lump sum, though, OK, or you could take the 10 year actually as well, which we’ll talk about here in a second, that’s available to everyone where you can get access to the funds over time without a 10 percent early, withdrawal penalty.

Mark Kohler: Ok, so I’m a surviving spouse. My first and probably the most typical choice is to do a rollover and just put it in my retirement account. Now, that means also, if your spouse had a Roth IRA, you would roll it in to your Roth IRA. Or if you didn’t have a Roth IRA, you would have to. Well, actually, when you have an inherited Roth or inherited IRA, you actually set up. Well, no, if your spouse you just roll it in.

Mat Sorensen: Set up your own. Yeah. If you if you had a Roth IRA, like you said, it would just go to your Roth IRA if you didn’t have one. You just set up a new Roth IRA. That’s your Roth IRA. And these funds are assets get transferred to it and we’re due on those constantly here at Directed IRA.

Mark Kohler: In this new inherited IRA account that’s going to come in option two we’ll come to that. Now, I’m the spouse and my surviving spouse in my husband or wife died and was currently working and had a 401k. What happens?

Mat Sorensen: Same thing, the 401k, you can do a spousal rollover on a 401k to an IRA if it was traditional 401k dollars and a traditional IRA Roth 401k dollars can go to a Roth IRA.

Mark Kohler: And if I was a surviving spouse and had a current job with a 401k, I suspect I could do a plan-to-plan transfer no or would it have to go into an IRA first and then back into the 401k. Can I put it in my 401k at work?

Mat Sorensen: Not at work, because, I mean, possibly I’ve never seen anyone do that.

Mark Kohler: Or solo 401k. I don’t know. Yeah, yeah, I’m just I’m the one that’s like Mat even tells me this before the podcast. Don’t ask questions you don’t know the answer to. That’s a that’s a typical rule a lawyer follows in court, this podcast throw it out the window. But I always start thinking of all these creative ideas. And and that’s you know that’s one of my.

Mat Sorensen: It’s funny because I’ve done this so long, I run into the questions of things people actually do. So sometimes I get a question, it’s like, well, yeah, I get that as a theoretical question why you’re interested in it, but no one does that.

Mark Kohler: Yeah, good point. Now, if they have a solo 401k in their small business, Then and you wanted to avoid UDFI or you wanted to borrow against it. More than likely you’d be able to roll it from a 401k to another 401K as the spouse inheriting that money, but a fairly unique. OK, now you said Mat option two for a spouse is if oh my gosh, I need to pay bills, I need to maybe pay off a debt, a mortgage on a property, maybe the home. My my income has gone down, my spouse passed away and I need that cash all at once. You said I could just take a lump sum distribution. Do I pay penalty?

Mat Sorensen: Nope, no penalties, so your 10 percent early withdrawal penalty is waived because you’re taking this distribution upon death of your former spouse, but you will pay tax on if it’s a traditional IRA, you will pay tax on the amount you distribute.

Mark Kohler: Ok, now, if you say

Mat Sorensen: So, we don’t like that unless you need it. That’s not smart unless you need it.

Mark Kohler: Yeah, but then option three is well I need it, but I don’t need all of it. And I have I’d like to have that as a safety net. Without a penalty, if I need it in the next 10 years. Because the surviving spouse may have other assets they inherited or their own retirement account, so they go, I kind of want this hybrid, that’s where the 10 year rule comes into play. Can you explain that?

Mat Sorensen: So the 10 year rule is is is new, this is under the secure act, by the way. So this came into effect a couple of years ago under this 10 year rule. What happens is upon the date of death, the heir who is inheriting the account has 10 years to take a distribution of that asset. So you receive it in an inherited IRA and you have 10 years now to take a distribution. You could take a little bit year one a little bit year two, a little bit year three, you could hold it all off until year five. You could decide at year six. Oh, I want to just take it all out and clean it out because I need it all. You have just that 10 year window to kind of do what you want with it without early withdrawal penalties and but again, tax, if it’s traditional for what you do take out no tax, though, in the Roth. And and so that’s the 10 year rule.

Mark Kohler: Ok, now if I’m thinking strategy. And my spouse passes away, hey. They leave me a traditional Ira or a Roth. And remember, a 401k is going to be in the same character. It’s either going to be a 401k tradition or 401k Roth. If I inherited a Roth I would be and I would be inclined to say, do the 10 year on the Roth and maybe do the rollover on the regular traditional, Because if it does, if I was a spouse, I’m thinking I’d want to have that Roth inherited because then I could pull it out tax free any time in the next 10 years and I’d have to drain it in 10 years, but at least there’d be no penalty and no tax. If I do a rollover and I’m not fifty nine and a half, I’m going to have problems accessing that.

Mat Sorensen: Yeah, it depends on what you want and how old you are. Let’s say let’s say you’re you’re 50, you know well and you’re going to be nine and a half years, you’re gonna be able to pull that money out of your Roth anyways if you did a spousal rollover to a Roth IRA. Now you won’t have access to it for that nine and a half years. But eventually you’ll get to the money, but you can keep it invested as a Roth. Through the rest of your lifetime, with a total tax deferral, growing tax-free, coming out tax to free, tax free, so I tax, I actually would go the other way, frankly. I would say go Roth as a spousal roll over and and maybe you do the 10 year rule on the traditional because if that’s a pot of funds that you’re like, well, maybe I’ll need that money. And frankly, you’re only going to pull that money out if you’ve got a low income. Right. So you’re not going to pay a lot of tax on it because you’re only going to use it if you need the income. Yes. And I probably go know if you’re like, I don’t need the money to live on right now, do spousal rollover on both accounts and just continue the same tax deferral. So I think what you want to do is take a take an assessment here and say, do I need this money or not? Can I let this stay for the long term? Do I need the money or not? Now, let’s say you’re already fifty nine and a half, you know, spouse, you’re over fifty nine and a half already due the spousal rollover all day long. There’s no question at that point because you can take the money out day two once you roll it over.

Mark Kohler: Now here, let’s talk strategy still. This is, this is where I think Mat and I complement each other. I’m a button pusher. I was a little kid pushing buttons just to see what happened. As I think most five year old boys are. So I would think that if I’m trying to build up my retirement. And I’m married. If you’ve got the funds from the success of your business or your building wealth when possible, you want to double down. I wouldn’t want to build my wife Jennifer’s Roth at the same time I’m building mine because if she passes away, I’m going to have both and vice versa. If I pass away, she’ll have both. And so I think a lot of married people forget to say, well, yeah, the Roth contribution of 401k is 19.5 or six thousand and a regular Roth this year. But if I’m married, I can double that and I’m going to inherit it anyway. And if you do get divorced, you’re going to split retirement assets down the middle anyway, typically I don’t want to foray into divorce law with retirement accounts. We should do it. We should do a podcast and get a divorce lawyer in here on that one.

Mat Sorensen: Perhaps. Kind of like the five tips every business owner should know from their divorce lawyer.

Mark Kohler: I like that one. Ok now, but again, the strategy is when you agree Mat, that whatever you’re contributing to a retirement account, if you’ve got the funds double down, Would you not say that?

Mat Sorensen: Yeah, absolutely. Absolutely. That’s and that’s that’s one of the great things about being married. I mean, there’s many reasons, but from a retirement account tax standpoint is you each get your individual contribution amount, so you’re able to double up on these things. And even when you have a working spouse and a non-working spouse, sometimes that’s the case. If there’s kids at home, you know, then, you know, you can do what’s called a spousal contribution or if the other one doesn’t have income at the time, you can use the working spouse’s income to make that contribution. So pretty cool there. There was some forethought there, I think, by Congress on letting married couples double down on these, even with the, like I said, the non-working spouse working to that spousal contribution.

Mark Kohler: Yeah. Now, I, I love how Mat just flippantly says, oh, there’s all these benefits to being married. When we get to the single person, make sure to remind Mat there’s all these benefits of being single for long. OK, now I’m going to throw out one last strategy.

Mat Sorensen: Not touching that.

Mark Kohler: Like I said, I’m walking a fine line today. OK, so what is going to rule out is one more strategy. Now, Mat, we also said this was kind of a weird hypothetical, but I actually think. Being strategic, we have a lot of engineers that listen to our podcast and engineers are strategic. They love this stuff. So Mat, I’m speaking to our audience, so just chill out. So, I think the rule is and Mat said before the show, he’s like, we’d have to research that, but my belief is and if I had to put down one hundred bucks, I bet this the election you take on whether you’re going to do a lump sum, A 10 year or a rollover is based spousal rollover, spousal, spousal, whatever the on the spouse side. Is, it’s going to be a per retirement account election. You’re not going to be able to divide up the retirement account. You’re going to have an accountant les Schwab.

Mat Sorensen: Les Schwab, For your tires.

Mark Kohler: Charles Schwab. So I obviously need new tires. So that’s going on. So I have a retirement account at Charles Schwab or Merrill Lynch or wherever Oppenheimer or directed IRA. That account is where I’m going to have to make my decision. I won’t be able to parse it. So I think the strategy here would be and we teach this anyway, because you can have multiple Roth accounts and you can have multiple traditional accounts, some you may self-direct in the stock market, some you may self-direct with private placements or notes or real estate. And so I think the day has come Mat too in our day and age that people just don’t have one IRA or one pension or whatever. They’re gonna probably have multiple accounts. And so the beauty of this is as a surviving spouse is you can say, well, this Roth, I’ll do a 10 year, this one I’ll do a rollover. This one, I’ll do it. A lump sum or so. I think if you are married and you’re really doing strategic planning, you’re going to have multiple retirement accounts and therefore you could choose multiple strategies based on the number of accounts. So I think people are wondering, well, if I choose one is that for all the accounts? Nope, it’s a per account decision. Wouldn’t you agree with that Mat?

Mat Sorensen: Yep. Yep. And yeah, I think there that’s an awesome option.

Mark Kohler: That interest rate strategy. Say it. 

Mat Sorensen: I didn’t want to start. I didn’t want to I just going to say it was a great scheme, you know, um. There are strategies and schemes you want to make sure you’re doing strategies now. But that’s I think that’s it’s very pragmatic too. And I think the reality is when someone’s sitting down at the end of the day having to make these decisions and it’s tough, I get it. You know, these are hard decisions is you do want to be a little pragmatic about it and and not just go all in going one direction or the other, think of your finances. Think of what you’re going to need for the next five, 10 years. And if the retirement accounts are an asset, you’re going to need make some of these decisions a little different per account based on how much you’re going to need.

Mark Kohler: Ok, now, believe it or not, Mat said at the beginning, this is the easier side of the equation. Yeah. So now are going into a little more complexity. We’re going to go over to where the grass is really green. You’ve looked over the fence and you’re like, you know, what are those single people doing the running around? They’re going to parties or frolicking around on that green grass. Some of you may go Mat. How is it over there? What’s it like.

Mat Sorensen: It’s it’s great. You know, it’s great. Let’s just do that, it’s good.

Mark Kohler: So now I’m not married and I inherited an IRA. So for anybody, this could be an ex spouse, a kid, and this is where it’s going to get complex. I want to talk about minor children in a big way, but. Where do you start there?

Mat Sorensen: All right, let’s let me make one note here before we get into the options, there was a rule change. So if you’re listening, that’s your thinking, guys. What about the life expectancy method? Used to be something called the life expectancy method, where let’s say you’re you inherit a retirement account from parents or grandparents or anyone. It’s not a spouse. You just you inherited from someone else. There’s something called the life expectancy method where you could take that retirement account and you had to take distributions. But it was over your lifetime. So if you were 40 and you inherited, let’s say, your parents retirement account, who passed away, you got to take distributions of that account over your lifetime, which the IRS thinks is going to be like another 50 years. And so you’re taking like, you know, one or two percent of that account essentially out every year because that’s what 50 years and the rest of it is to stay invested. All right. Now, that was really cool for people who wanted to do what’s called a stretch IRA let you stretch out the life of that. The Roth was even cooler because there is no RMD, but you still got to use that account over your lifetime. And so that rule that there’s no tax on there and you should say that rule was in place and is still there, if you inherited account prior to 20, 19 of taking effect, you still get those old rules. But for people setting up accounts now, they’re inherited accounts from someone that passed away in the last year or two. Now you’re operating under these new rules. So I just want to note that there’s this life expectancy method that some of you may be on. If you have an inherited IRA previously, you’re following those old rules which are great for like the child that received the parent’s account and you get to take it out over your lifetime now, OK? 

Mark Kohler: And one aspect of that, too, was if you’ve got it from grandma, grandpa or a spouse that was over age 72 and or 71, 70 and a half, and they were doing what’s called RMDs required minimum distributions. And we’re going to we probably should have defined that term earlier. It was a lot more. Applicable under those old rules, because an RMD said you’re required to take a minimum distribution over some sort of calculation, but all that’s gone now. So it doesn’t matter if they were already doing RMDs, they were over 70. Doesn’t matter how old you are anymore. The government said we don’t want to let anybody sit on these retirement accounts longer than 10 or ten years period.

Mat Sorensen: Yeah. So. All right, let’s go over your options now. You’re a non-spouse inheriting an account, and maybe this is the boyfriend inheriting an account or this is the child, whatever. Your first option is Lump-sum again, you can just take a lump sum, all right, and that again, you’re going to get taxed on it. There’s no 10 percent early withdrawal penalty, but you’ll be taxed on if it’s traditional, no tax if it’s Roth. One thing I’ve seen in this that’s important, that that’s an option, too, is to disclaim it. We’ve had that recently where let’s say. You know, my grandparents passed away and passes the account, the beneficiary on the account is your mother and your mom’s like, well, I don’t want it. I’ve got plenty of assets. They can disclaim it and pass it down to the next beneficiaries, which are maybe grandkids or even maybe a different sibling or something. So we’ve seen that where you can disclaim to kind of let the account go down to the next generation who maybe have better use for that asset. So just that’s that’s an option, too, as always, the disclaimer.

Mark Kohler: But if I’m right, it would have to go to the benefit of the contingent beneficiary that was listed on the account, by grandpa, I’ll just claim it and give it to my favorite kid. Nope. It’s number two on the list that Grandma Grandpa chose.

Mat Sorensen: Exactly. Yep. Yep. So that would have been planned out. Yeah. That would have been planned out. Or, you know, your grandkid would have had to been on the beneficiary designation forms as a contingent.

Mark Kohler: If you don’t like your sister, you don’t want to do that because. Yeah. Why.

Mat Sorensen: Ok, yeah. OK, so

Mark Kohler: But this is where the strategy comes in. OK, so you’re not at the poker table. You’re at the dining room table. And grandpa or grandma, oh, this is good, grandpa, grandma, mom or dad, we have all adult children sitting at the dining room table. We’re looking at the house, the land, the farm, the rental and all this. And there’s this Roth IRA over there. And what the parents do, they name their spouse. And then all the kids as equal contingent beneficiaries. Probably the most common right at the table. You’ll say. Well, I didn’t inherit a Roth. We all did. You say no, no. Not everybody at the table. If you guys will all sign this disclaimer and let me just have the Roth, then I’ll give up my share of the house or the farm or the whatever we appraise. So you’re going to get the same amount of dollars, but you can use the disclaimer to talk everybody into letting you have the Roth account entirely.

Mat Sorensen: And, you know, one from a from an administration standpoint, a lot of times that’s easier because, you know, let’s say there’s four siblings and their kids get one fourth of the account. They all got to go set up a new account if they don’t have one and roll it over. And it can be a little bit of some paperwork. And everybody’s got to do it rather than just saying, let me take this, you take that, let’s split up the cash here. I’ll get more of this because you got that. You know, sometimes assets move that way because it’s just simpler to distribute. And so raise your hand to take the Roth IRA. You’ll because let’s let’s state why let’s make it clear why you have that. Let’s say it’s $100,000 Roth IRA account and you’ve got let’s say you’ve got one sibling. Let’s make it easy. And there’s a checking account with one hundred thousand dollars that your other siblings going to get, OK? And so, like, you just take that checking account with one hundred thousand at the bank. I’m going to take this Roth IRA over here. That’s one hundred thousand dollars of value. OK, ok, OK. We got 50/50 where the two somethings now. Now you’ve got 10 years of this hundred thousand to grow and it’s going to come out tax-free. So you turn this hundred thousand into one fifty or two hundred over the next ten years. Now you’d get two hundred thousand come out of that account. No tax at all. All right. So you’ve got this tax-free vehicle to grow for another 10 years. Your sibling that took the hundred thousand checking account of just cash, they turned that hundred thousand two hundred grand. They’re paying tax on one hundred thousand dollar appreciation, you know, so so that’s that’s why we like the Roth as it’s just this tax-free vehicle, particularly when you inherit it. It’s already got some assets and money and it’s kind of primed and ready to go. You get a 10 year run on it. Kind of cool.

Mark Kohler: Yeah. And a couple other things that make it fantastic is you you can take out the money in stages yearly, wait the whole 10 years, wait nine years and three hundred and sixty four days and then drain it and all the money you earned in there is tax-free. Now, there’s a lot of rules out. There are rules of seven rules, but if you’re averaging a 20% return, that one hundred grand could easily turn into five hundred grand or some other things. So you’d start doing math on the future value of one hundred grand. You can pull up any website calculator to do this and put in an interest rate or a rate of return because you’re listening to the show because you’re like, hell, I could take that hundred grand and do notes all year long with points and interest. I could average 15 to 18 percent every year. You do the math on that. That’s all tax-free. And the beauty is you can take it out any time you want. You can just walk over there to the Atm next year on a Thursday and November and go, I need 50 grand. I need 20 grand. No penalty. No tax. That’s why it’s the holy grail babie.

Mat Sorensen: Yeah, that’s so that’s the trick. There you go. OK, let’s say you don’t want to do Lump-sum, we’ve hit we’ve discussed this 10 year rule just briefly there, that’s the the most common option I think a non spouse beneficiary can do, is that you have 10 years to the 10 years to distribute the assets.

Mark Kohler: Oh, yeah. We have to do. We can’t do. The spousal rule, spousal, yeah, that won’t work.

Mat Sorensen: Correct. That’s unique to spouses where you can come into an account in your name, so if you’re not a spouse, you’re going to be the lump sum or really the 10 year rule.

Mark Kohler: And that’s what I wanted to just say it just so you’re all were like, why don’t I can I do the rollover? Nope. So just to get it out there so that there’s no miscommunication or Is that that one rollover option is unique to spouses? And you say, well, it’s my mom, it’s my dad. Doesn’t matter. It’s my ex-wife, it’s my ex-husband doesn’t matter. So that you’ve got to be married as of the date of death and in order to make that election, to roll it over to your type of same type of account, whether it’s a Roth or traditional. 

Mat Sorensen: Yeah.

Mark Kohler: But your two options are stretched over 10 with no penalty, your tax, and I can take it at any time, whether it’s Roth or traditional or do the lump sum. Now, can I explain what IRD is Mat? So IRD is called income in respect of a decedent. Now, this is the bad news of the show. Oh, by the way, I’ve got good news, bad news. I tell you about it. We’ll come to that right after. But the bad news here, if anything, is this IRD, because you might say, well, if I inherit something, I don’t I don’t pay tax. Well, that’s if you inherit a home stepped up basis, you inherit a life insurance account, no tax, you inherit a Roth IRA, no tax. But if you’re at the dining room table and there’s a traditional IRA sitting there. You don’t want that. You want to say you want to say, hey, Bro, sister, take the traditional IRA, you can stretch out over 10 years. And they’re like, oh, that’s nice. But because mom and dad never took out the IRA and paid tax, the person that inherits it has to claim that income in respect of a decedent and pay the tax as if mom and dad had taken it. So the strategy is here. And this is like you’re playing rook, you’re playing poker, you’re playing who knows what card game you’re going to want to grab the Roth, you want to get it, get rid of or discard the traditional IRA because you don’t want that IRD, that income in respect of the decedent sucks. And so when you take a lump sum, you have to pay IRD and it’s not at mom and dad’s tax rate. It’s whatever your tax rate is that year, your marginal rate. So if you’ve already made two hundred grand that you’re 50 grand or a hundred grand when you pop in that IRA money in a lump sum, it’s going to get it’s going to bump you into a higher bracket and you’re going to have to strategize over 10 years. That’s right. Mat, of course, and take the 10 year damnit. It’s just better that way because you can even spread it out within three years and just keep yourself in a lower bracket rather than going to the highest bracket all at once. Now, if you’ve got to pay off the mafia or you’ve got a huge mortgage and you’re going to lose the family farm, maybe you have to rip the Band-Aid off and pay a crappy tax rate. But if not, you want to strategically take it so the IRD keeps you in a lower bracket over that 10 years. Mm hmm. Do you like that?

Mat Sorensen: I like that. Yeah. Yeah.

Mark Kohler: But I was skeptical about explaining IRD.

Mat Sorensen: Like I was like that. Leave it to a CPA tax lawyer to throw out an acronym that even I didn’t know after reading this stuff for so long. All right. What’s the good news and bad news, though?

Mark Kohler: Oh, OK. So I.

Mat Sorensen: So is the good news you have IRD or was that the bad news?

Mark Kohler: No this is off topic, go lively and interesting. And so we have so many engineers that love our show. So you guys love this. So I was on my it has to do with Tesla. So Tesla. Tesla, I was on my Tesla Login on Tesla.com So do you want the good news. Bad news first you choose.

Mat Sorensen: Give me the good news,

Mark Kohler: The good news is I’m in the front one-third of the line for my cyber truck, so if there’s one hundred people in line for a cyber truck, I’m in the third, I’m one through 33. I’m right there in the first 33% of people to get their cyber truck. That’s I they finally have you can you can do a calculation. If you go to Tesla and you’d ordered a cyber truck, you can do the math to figure out where you’re at in line. So that’s the good news. 

Mat Sorensen: And the bad news is.

Mark Kohler: The bad news is I’m number 232,000 and change. But that’s ok.

Mat Sorensen: I thought the bad news you’ll be driving a Tesla truck

No, a Tesla. Everybody wants a Tesla Truck because They’re so kickass. They’re so cool. Almost bulletproof Elon Musk. Yeah, he did the first test case with this baseball bat, but we’re going to it’s improved, but the truck is looking good. 2022, they’re going to start delivering. And I’m number 232,000 and some change. There’s over 750,000 orders now, so. While I’m in the front third of the line.

Mat Sorensen: Cool, you don’t want a GM truck. You know GM is going all electric by 2035,

Mark Kohler: Or how old will I be in 2035? I’ll be driving a lowered Cadillac in Boca Raton in 2035.

Mat Sorensen: Cruising around Boca Vista,

Mark Kohler: I’ll be driving a Golf cart around Florida communities, calling out people in their garbage cans out on the street. Hey, get your garbage can in, you jerk.

Mat Sorensen: All right. Ok, sorry for the diversion there. The pardon, the little little joke they’re in them. And I appreciate that, Mark. That was funny. Ok, all right, let me say this on inherited IRAs, because I made this point at the beginning again, if you’re Self-directing, you have to think of this stuff like, all right, if I took the 10 year rule, you know, I eventually got to sell this asset in 10 years. So let’s you know, let’s say you inherited a Self-directed account and it’s an inherited IRA now and it’s got a piece of real estate in it. Well, that’s not a liquid asset. You’re just going to sell it on the market, whatever it’s trading at at the last day of 10 years to meet that rule. You got to plan for that. Make sure you sell. 

Mark Kohler: The market’s not going to coordinate, you know, its appreciation for you. It could be good, it could be bad.

Mat Sorensen: So maybe once you get in seven years, you know, you’re starting to think about that, like I said, I sell it now, where am I at? Or I need the money, you know, don’t wait till the last year to to make that decision unless you you know, you’ve got the magic crystal ball and know the exact time to sell real estate. So just keep that in mind is a little extra consideration for self-directed accounts that are inherited.

Mark Kohler: Ok, now next strategy as some. You know, non friends would say scheme to hurt your feelings if you’re out this weekend, but Mat would never do that to me. He would never use a word.

Mat Sorensen: But OK, just

Mark Kohler: I’m just not here for color commentary. Here’s the strategy I think is very important. What about kids that should not inherit my retirement account? They may be. Immature when it comes to money, they might have a drug addiction or some sort of addiction that could have be in a bad marriage, that could be a community property. I mean, there’s a variety of reasons.

Mat Sorensen: You know, debts and the creditors,

Mark Kohler: IRS is after him or who knows what. And you might have a five year old, a seven year old, and you’ve already got 500 grand sitting in an IRA or 401k and you’re like. Well, you guys drafted a trust for me where the kids get money when they’re 25, 30, 35 and they get money for college, money for a wedding to start a business, buy first home. But we don’t want an 18 year old run around with five hundred grand. By the time that five year old gets to 18, that five hundred grand is probably going to 1.5 million because you’re self-directing and you know what you’re doing. So what do you do? Well, before the secure act, approximately 10 years ago, there was legislation passed for what’s called the see through trust. Now, the see through trust is a provision under federal law that says if you draft a trust, that meets four criteria. Then when you die, you can name the trust as the beneficiary of a retirement account. And we’re going to look through it and let the kid or whoever the beneficiary is. I’m going to say it this way, we’re going to look through it and let the trustee make any tax selections on behalf of a beneficiary that made the best sense or the most sense from a tax perspective for the beneficiary without taxing it at trust rates. Now and I’ll shut up here in Mat, I know you’ve got a lot to say on this, too, but the problem was before is parents would say why if I’ve got one hundred thousand dollars IRA, I’d rather pay tax at 35%. And give the kid Sixty five grand when they can handle it, rather than just give them one hundred grand now and have them blow it, even though they might have a lower tax rate because what kids will do. Guess what they’re going to choose lump-sum and they’re going to be driving around a Ferrari and you’re going to be up in heaven very disappointed these people drop you off here. So the see through trust was a way to say, you know what, we’ve kind of got the best of both worlds. We want to we want to hold the money in some ways for the kid and have that safety net. But we also make a tax election if it makes sense. And if this sounds complicated, It is, But it’s an option. How Mat what’s your take on it or explanation to. It’s kind of fun topic.

Mat Sorensen: Yeah. See through trust, one of the rules on us has to identify the beneficiary. So the trust terms itself, we need to identify who are these beneficiaries. And so, you know, what I always recommend clients to is when you’re doing your retirement account beneficiary as a default, every situation is unique. But as a default list your spouse first if you have one and then your trust second as the beneficiary of your retirement account. That way, if you have minor children, you know it’s going to pass according to the trust terms. Now, let’s say you’re like, you know I’ve got. Go ahead.

Mark Kohler: Mat needs to make a correction there. If you’re married, you name your spouse first. If you’re single, you name your law partner first and then you’re kids.

Mat Sorensen: Yeah. Now I might need to update forms.

Mark Kohler: That’s a big update by the way it’s in your email. Go ahead and open that up. Just verisign that don’t even don’t even read it.

Mat Sorensen: Ok. All right.

Mark Kohler: All right. So the beneficiaries get the IRA, the beneficiaries. Get this. IRA, keep going.

Mat Sorensen: Yeah, yeah. So the trust is going to identify them and then and then let’s say you pass, your spouse is already predeceased you. It’s going to go on to the trust now and it’s going to pass down to the kids. Now, let’s say you had two kids, so there’s going to be the trustees are there’s two kids here, the beneficiaries of this retirement account. And let’s say one of them, you know, pretty good with the money. And what I think a smart trustee would do is just do a 10 year rule on both of them to inherited IRAs on both of them, and then let that let that money stay invested and then distribute it out at the end of 10 years to them and let them let them take that account and basically, you know, and let them be involved in investing it. Of course, this is your account and and let them be involved again. If they they know what they’re doing now, they could have the other situation, though. They don’t know what they’re doing or they’ve got a drug and alcohol addiction. They’ve got financial issues. The trustee may kind of divvy out money as they go year to year. Right. And say, hey, I’m going to maybe give you a 10 grand through the year to whatever it is from this account. But the trustee can kind of dole that money out according to the trust terms of what you’ve had in there. And our our estate plans have those standard terms in there for addiction or creditor issues where the trustee can withhold distributions of any asset, the retirement account assets that they are controlling here, or any of your cash accounts or equity in your house, whatever may come.

Mark Kohler: And in our standard trust design for every client in the country. Single or married, we have the see through provision, so we comply with those four parts of the test. And I’ve got a really touching, a touching story here, I’m not just here for jokes, too, but here in a moment. But you you want to maybe elaborate on that provision. So we charge fifteen hundred bucks for an estate plan, Any estate Single or married. That’s our standard. You get an hour or so with the attorney paralegals that are to help you it freaken rocks and we meet people all the time. That said, I spent three grand, or I spent five grand. And we’re like. Look at our Docs.

Mat Sorensen: Yeah, at least I’ve had clients 10 you know, 10K plus on estate plans.

Mark Kohler: Really bad. There’s a lot of lawyers that value bill. And and we get ee we’re not liked by a lot of attorneys that are in estate planning realm because they think we’re too cheap and we’re like the Docs Rock. We’ve been building it for 20 years. They have every bell and whistle your freaking docs do. And we just want to be affordable. Now, it is true, though, when we have a client that has a net worth, that requires an AB trust or here’s what I’m getting to. You want to kind of put some provisions like Mat just said, where the trustee has this ability to divvy out money, do the 10 year deal, but at the tenth year. When this kid or one of them shouldn’t really get the money, we want to type in provisions that you give to us, that we would say, you know what? Take the distribution into the trust, pay a higher trust tax rate, even though logically that would not be a good move financially, but it’s a good move. Personally for that child. And, so when clients come to us and say, I want your trust 1,500 bucks sounds great, and then we in our consolt, we talk about things like this, you, his kids, her kids marriage. Second, we’re going to add some hours there is you want to kind of fine tune things and that’s OK. But we don’t have this flat fee where everybody gets hosed for five grand or ten grand. We’ll start at fifteen hundred and we can add some bells and whistles. So when you’re working with one of our attorneys, make sure you bring that up and go, Hey, hey. I remember when Mat and Mark were talking about this see through trust and I’ve got a 10 year old and in 10 years they’re going to be 20. And I don’t know if I want them getting that money because you got to give it to him within 10 years. So you may say, pay the damn tax, I don’t care if it’s 10% more at the trust rate versus the kid’s individual rate, because that’s what’s best for my kid.

Mat Sorensen: Yeah, and keep in mind, when you’re distributing funds out on a traditional IRA to the kids, you know, they’re paying tax at their rate. So the heir of that account. Now, that’s good to distribute out over time. They’re not getting into a huge tax rate. The individual rates are lower than the trust tax rates like Mark was mentioning there. So that’s the more efficient way to do it. And at the end of the day, it’s at the end of 10 years and there’s a large balance still left in the account. And the kid is in good financial situation. They’ll they’ll have to distribute the whole thing to them and they’ll get a large tax bill that year for the large distribution. But but that’s that’s the right way. The problematic child, you know, that has their financial issues or other. Protecting that money and future problems that giving them that money could have is worth the corp, the trust tax you’re talking about, Mark, I think that’s a really smart thing to think about for those that run into this situation. And it does. It comes up.

Mark Kohler: Yeah. Yeah, it does. And as an aside, some you may be going, well, what if it’s a Roth? Then there is no trust rate and there is no individual tax rate. The see through allows the kid to get the Roth tax free at the ninth year, 364 day. But again,

Mat Sorensen: It’s no longer a retirement account and it’s just basically cash, you know, it’s an act or an asset. So but the trust still would own it.

Mark Kohler: Yeah. Now, if you don’t take that Roth distribution because it’s in the worst. Result for the child by not distributing it within the 10 years, then a Roth would have some penalties and tax and I don’t know the calculation, but it’s not good.

Mat Sorensen: 50% penalty. Yeah. So do not mess with that 10 year rule.

Mark Kohler: Now is that for IRA’s too or just the Roth?

Mat Sorensen: That’s for all accounts, not distributed, but within 10 years.

Mark Kohler: Wow, man, do you give your 21 year old. A million dollars when they’re 21 years old or pay the tax of $500,000? And wait till they can handle it. That is a tough decision.

Mat Sorensen: Well, you still distribute the Roth out. You close out the Roth and let the trust pay the taxes. But now the trust just owns the assets. There’s no Roth account anymore.

Mark Kohler: Well, that’s what I mean we pay five hundred grand in tax and then be able to hold that last $500,000,

Mat Sorensen: You mean trust tax rates not the penalty.

Mark Kohler: Well, or whatever, I mean, the penalty is 50% plus tax?

Mat Sorensen: Well, the penalty is 50% plus you have the tax to pay because you still have to get the asset distribution. But I’m just saying, if you are, you’re the trustee. You’re coming on 10 years. You got a kid that you don’t want them to get the assets of the trust. Yeah. So do a distribution close out the Roth, but the trust owns the assets. Now, the distribution went to the trust. Yeah. So there’s no 50% penalty, but the trust is going to pay all the taxes because it cuts all the income. But with the Roth, it wouldn’t so. What I’m saying is the Roth IRA ends, but the cash that the Roth had, if you get it, cash, let’s say at the end of the day here, would be an asset of the trust, which it would still hold. So the 50% penalty would not apply.

Mark Kohler: But here’s my take. Now, whenever Mat and I debate legal rules here on the podcast, just realize this is what sometimes clients are like. Well I have that situation I’ll pay you to research it. I don’t think Mat and I have the time today. But here’s my issue. I’m just going to say technically and some you might appreciate this because you love a good. Cerebral podcast. Is let’s say there’s the million dollars there, it’s in a Roth and I’ve got I’m the trustee and I’ve got to see through prevision, I’m coming up on the tenth year. Now, the reason why the Roth is tax-free. Is because the trust is required to give the money to the beneficiary in order for it to be tax free. See, the 10 year distribution rule is I got to distribute it to the beneficiary named in the IRA by the tenth year. If I take it into the trust and don’t distribute it to the Kid, I think even if it’s a Roth, you’re going to pay trust rates because you didn’t follow the rule and actually give it to the kids. Now, I think you’re right, you avoid a 50% penalty.

Mat Sorensen: But I agree with what you said. Yep, I agree exactly.

Mark Kohler: Ok, OK, So the Roth would probably pay tax you pay tax on the Roth.

Mat Sorensen: Yes. That makes sense, which sucks. But. OK, if that got deep for you guys we’re sorry. That was that was a little I was pretty geeky.

Mark Kohler: Yeah. Now let me tell you a heartwarming story and it’s also a scary story. And I’ve got to be really careful with the details because this is a current client and a case in our office. But I met with this client twice in the last two weeks. She is now 21 years old. Ironically, based on some of the other little comments I made throughout the show, she actually is 21 years old. She has three younger siblings. And her mom and dad both died within a month or two of each other. About two years ago, and family and Community came to rally for her and her family, And I was recommended to help out and I hope now and I’ve been doing it pro bono and helping this oldest daughter, who’s 21 now and. I don’t want to get emotional, but I’ve just been so impressed there was assets, there is no will, no trust. There was retirement accounts, there were Social Security, all sorts of stuff. And to this girl’s credit. She freaking put it all in the bank, went to college and I swear she spent five percent of it just on really. Basic conservative items, and I’ve really been a cheerleader for her telling her that she is years beyond her age and wisdom. And I’m so proud of her, so she’s listening to the show and she’s starting to get a Self-directed account going with some of the retirement accounts and all these sorts of things. And and her parents died before the secure act. So she has a really long retirement account. I Just want to tell everybody that that is probably the exception, not the rule, and I have to even probably admit if I was a kid at age twenty one and someone gave me one hundred grand in an IRA and I could pay A penalty, I don’t care. Give me the money. And certainly, you know, and so but anyway, the point is I think too many parents have faith in their kids. I meet with so many parents that are like, yeah, I’m just going to make my oldest kid the trustee and I’m going to they can have all the money when they’re 21. I’m like, what are you smoking? Don’t you remember being 21? I mean, now maybe you were, you know, goody two shoes, nerd of the class. And I wish I could look back at myself and say, yeah, I was pretty smart at age twenty one, but who knows what they could be facing. A bad boyfriend, a bad girlfriend, financial issues, credit card debt and you’re going to put a lump sum of money in front of them and they can and there’s no restriction that they can tap into it. Be careful, people,

Mat Sorensen: Yeah, yeah, yeah, that’s true, and retirement accounts have been one of the greatest assets for Americans that it’s getting passed on to the next generation. So it’s really particular that you plan for this asset. It happens on the beneficiary designation form again and can be in connection with your trust, as we mentioned here on the see through trust provisions. So hopefully understand the options here, whether it’s planning for yourself or you’re in the situation now trying to decide what to do with an account that you’ve inherited from a loved one, whether it’s a spouse or a non spouse. So I do want to say to we do have a page on directedira.com if you just go to inherited IRA account page at directedIRA.com. There are some articles that summarize these rules. You can just see it in writing. Sometimes it’s easier to just digest it and writing to after hearing it as you’re making the selections on what you’re going to do with your Inherited retirement account.

Mark Kohler: And it’s easy to change some of your like oh my gosh, I don’t even know who my beneficiary is or it’s my ex spouse from 10 years ago or I have no idea. Deal with it. And I’m going to Finish with one last strategy, too, which I think is a little cherry on top kicker. But talk about this issue in your annual planning strategy session with your tax lawyer, your accountant, your lawyer, whoever it is, hopefully maybe someone in our team that takes a holistic view with tax and legal and asset protection all together. But bring us up, say, hey, what is our plan with an inherited IRAs? If your adviser can’t talk intelligently on this topic. Maybe you’re not going to fire them because they’re good in other areas, but you got to be talking about this with someone that knows what you’re doing because it’s just something you want to jack up. That’s technical term, by the way. And here’s my last strategy, OK? My mom gosh another emotional moment. My mom is awesome. I love her. My dad died 10 years ago, approximately, but my Mom is not doing well, dementia. And she’s going blind. She can read books or watch Golden Girls, which I would watch with her love, Betty White. But she’s not doing well, but. I’ve talked to her, I’m like, I’m going to set up a Roth IRA and I’ll give you the money and let’s fund it and I’m going to be your beneficiary. And she’s like, OK, I don’t care. My brother and sister are like, whatever. If you give her the money to do it, you can have it. And so I and I don’t think that’s being morbid or I’m just trying to plan as a family. So I’m saying now I can triple down, see, so I’ve got mine, my Spouses and my mom’s Roth IRA that I’m funding. And I’m the beneficiary of those other two and, well, all three and my wife can do this with her parents. And so if you have a parent out there, young or old, doing a good in health or bad, You may say, hey, talk to your siblings and go, I’m going to open up a Roth IRA over directed IRA and start self-direct in it. But I’m going to put the money in and I get it in writing, get it in writing from all your siblings that they say, OK, that’s your Roth IRA. We disclaim it, it’s not a part of mom’s estate. Because you don’t want to build that sucker up and then the kid, the brothers and sisters go, well, you got Mom’s Roth IRA, so you can put the money in there. That’s money. I just use that as a strategy so they’ll turn on you, trust me, at the dining room table. So sure you get it in writing from everybody that says we agree that’s not part of mom’s estate. You’re going to be the one to fund it and you’re the beneficiary. Yeah, but that’s powerful. It’s honest. Yeah.

Mat Sorensen: That used to be even a more popular strategy. But back when you could do the life expectancy method because, you know, before Mark would be able to inherit that and take it out over his entire lifetime, now he’s going to get a 10 year window, which is still good. You’ll get a 10 year window to keep investing that funds keep it tax free. It’s going to come out tax free in five years into that is like I want to take it all out. No tax. Pretty sweet. So that’s the strategy. OK, well, thanks everybody for tuning in to the Directed IRA podcast. We will be back, of course, next week with.

Mark Kohler: Say the authoritative word.

Mat Sorensen: Ok. The most authoritative podcast on on any topic out there in the world.

Mark Kohler: Love it.

Mat Sorensen: Yeah. So but thanks again. I hope you learned something again. Go to directedira.com/podcast to learn more about the podcast and see prior episodes. If you don’t know what the heck self-directing is we’ve mentioned it a few times here and you just found this on inherited IRA’s go back to Episode one, you can learn what Self-directing is all about and how you can buy alternative assets like real estate, crypto, private companies, funds, hedge funds, all in an IRA. It’s called a Self-direct IRA. And it’s what we do here at our company directed IRA. Thanks for listening.

Mark Kohler: And well, next week, should we do open forum? Next week we call it.

Mat Sorensen: Let’s do open forum. Good. Yes. So go to directedira.com/podcast where you can enter in your questions. We will be filling those questions during the Open Forum podcast next week. Love it.


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