RMDs: The IRS Wants Its Cut – What You Need to Know

In addition to taxes (and, unfortunately, death), one constant for people nearing or in retirement is required minimum distributions (RMDs). Recent legislative changes from the SECURE Acts affect both the age at which you’re required to start taking RMDs, and how those RMDs are handled when a retirement account is passed down to heirs.

In this episode of Capital Conversations, CERTIFIED FINANCIAL PLANNER™ Professional Colin Day and Accredited Investment Fiduciary® John Biedenstein discuss the recent changes to RMD laws, strategies to maximize your growth from inherited retirement accounts, and how you can work together with your financial advisor and tax preparer to limit your tax liability.

For recent investment news and our take on the current market, retirement planning, and investment, listen to our podcast Capital Conversations or view our recent blog posts.

Below is the transcript for our most recent podcast, "RMDs: The IRS Wants Its Cut – What You Need to Know."



Colin Day: Welcome back everyone to another Capital Conversation. I'm Colin Day. This is John Biedenstein. John, welcome back.

John Biedenstein: Thank you, Colin. Love doing these.

Colin Day: I know you do. We're doing this first thing on a – what day is today? Thursday morning. So hopefully we have enough energy to communicate well to you all, our very important message today. And John, the message we want to communicate today is all about RMDs.

In the financial services world, we are full of acronyms. So, we have no shortage of them, but I want to talk about one specific one today.

So, John, why don't you kick it off? I'll hand it to you. What is an RMD?

John Biedenstein: So an RMD is a required minimum distribution that is required to be made from an IRA account or from a 401(k) plan that you might still hold, but once you attain a certain age, you’re required to take distributions from them.

So you need to remember it's from basically all retirement accounts that you hold. IRAs and 401(k)s.

Colin Day: And why does the IRS force us to take out minimum distributions?

John Biedenstein: Well, the IRS forces you to take minimum distributions because you've set aside a lot of these funds tax deferred. The IRS wants to get paid the taxes on those deferrals.

So any distribution, i.e. a required minimum distribution qualifies too, is a taxable distribution from the plan to you. The government also doesn't want you to have funds set aside that pass tax deferred to your heirs.

So again, it's a way of keeping people out of estate trust issues or estate tax issues, where if you are paid out of or taking distributions out of those IRAs or 401(k) plan accounts, then there's going to be a lesser amount that's left at the end that might pass on to your estate.

Colin Day: Right. And this is that concept of establishing a dynasty in regards to your wealth. Because, you might have millions of dollars in your 401(k) plan when you retire or when you pass away, which you hand down to children, grandchildren. They are able to then have that money forever, and they continue on with it and then they just massively grow their wealth.

Well, that's not what the IRS is going to allow you to do. That's the minimum distribution. They are requiring us to deplete those accounts saying, “Hey, you put money into your 401(k) plan, tax deferred,” (like you said). “Now we're going to start to force you to take money out every single year.”

Now there's two varietals, right?

John Biedenstein: Well – and the other thing is, one of the reasons why we're talking about this now is there were some recent changes. One of them pushed the age. I don't know how it ever came. Year 70 ½. It’s one of those things – I don’t know how they picked 70 ½ years.

But a number of years ago, they changed that required minimum distribution year to be when you attain the age of 72. So when that came out, as there's often done with IRS regulations, there [are] no guidelines in regards to how custodians, advisors, administrators of plans are supposed to administer this.

So they recently issued final regulations. So that's kind of what we're talking about today.

Colin Day: Right, exactly. And the funny thing is when Congress passes a law, they all high five each other and then they go home, and then everybody else, all these departments across the U.S. are forced to then say, “Okay, how do we actually do the things the law is supposed to require us to do now?”

So what John is referring to is the SECURE Act and there's two versions. There's SECURE Act 1.0 and then 2.0. And 1.0 changed a lot of the regulations, not just from changing the age of 70 ½ to 72 for those people that have these IRAs, these qualified retirement accounts through work.

But it also changed the inherited rules. So specifically, we're going to talk about the inherited rules, because this is where there was probably the most confusion for account owners as it comes to what they are required to distribute on an annual basis, or even if there is something that they had.

Now there's a dateline that I want to consider here. And the dateline that we're considering is January 1st, 2020. So, January 1st, 2020 is the dividing line for those people that have inherited an IRA account from a loved one in terms of what their big options are.

So again, when they passed this law, the SECURE Act 1. 0, they basically said, “Here's going to be the deadline.” For those people that are inheriting accounts from loved ones that have passed away on January 1st, 2020 or up to the current present, those are completely different rules from what was in the past.

John, do you mind maybe just explaining very briefly what perhaps some of the options were for loved ones when someone passed away before that January 1st, 2020 dateline? Say 2019, 2018?

John Biedenstein: Yeah, again, there were certain provisions that people could take advantage of. The most prevalent was that you had to take your distributions over a period of time and there was also a provision that allowed you to stretch the distributions amount over an extended lifetime. A lot of folks in the earlier periods, if there were children involved, they would pick the youngest child to try to extend the payment time.

Some of that changed. In the new [regulations], they're kind of clarifying all that. And they're saying, “This is how you follow these new provisions.”

Colin Day: Yeah. The stretch provision – really what its intention was was to allow those loved ones that are inheriting money that are much younger to be able to distribute over a length of time.

So, for example, if you’re in your 70s taking your regular withdrawals that you’re required to, it’s going to be a pretty sizable amount. Around 4-5% of the contract let’s say. Well, if that person passes away and hands it down to their son, let's say, who's 40 years old, well, they've got a much longer time horizon.

So the government was allowing individuals that are inheriting at a much younger age to stretch those payments. Because as you can imagine, that could be burdensome to that individual to need to take out a whole bunch of money from the account when they're in high earnings years. But they also want to provide this, not as a penalty to the person that was named as a beneficiary on the account, to do something that maybe they didn't want to do.

But as John alluded to, it all changed January 1st, 2020, where the new rules came into play. Now there is what's known as a 10 year rule when it comes to these beneficiary distributions. So, for [the] majority of individuals that are inheriting money. Now they only have a 10 year period. Whereas before the stretch option could be for their entire lifetime.

That 40 year old is going to live another 40, 50, 60 years, could stretch those payments over multiple decades. Now the rule, unfortunately John, is you only got the one, you only have the one.

When we think about what these final regulations have finally come through with, it’s providing some clarification on what that 10 year rule actually means.

Make sense so far?

John Biedenstein: That's correct.

Colin Day: So when it comes to the 10 year rule.

John Biedenstein: Not clear, but always, it’s correct.

Colin Day: What we have been waiting patiently for since basically 2019 is final regulations from the IRS to clarify all these rules. Because, for example, let's say your loved one passes away in the year 2020 and you're underneath this new 10 year rule. You are called a – what do they call it? It’s a “non-eligible designated beneficiary,” where you have that 10 year rule applied to you.

The first question was when does a distribution need to take place? So the first part was, if I am inheriting from somebody who's let's say 80 years old, who passed away. My uncle named me as a beneficiary on their traditional IRA. I take over this account in my forties. What am I allowed to do with this? How long do I have to distribute? And more importantly, do I have to take a withdraw every year?

Well, the clarity that we, again, as advisors have been waiting for, is that you have to take a withdrawal every single year in that scenario. Because Uncle Joe was taking an annual withdrawal already because he was required to do so because he was over the age of 70 ½, but now this individual that's inheriting those accounts, the year following death, they have to make an annual withdrawal.

So, for many folks, that means about a 10% withdrawal to deplete the thing in 10 years. Or, in that 10th year taking the remainder out. That's what the IRS is looking at.

John Biedenstein: Correct. Now it does allow those folks to take different amounts every year. You don't have to do 10% every year. You can fluctuate it. So, if you have certain years that you know, “Well, I'm getting a big bonus this year. I've got some compensation increase that's going to happen this year.” You could lessen it one year and then elevate it in other years down the road.

But that 10th year after the death, that's when the full assets have to be distributed.

Colin Day: Yeah. As you can imagine if you have inherited an account, it's not just going to cash. It's not just going to earn money market rate. We're still trying to grow this thing. The intention is that just because you inherited this thing and you don't want to pay taxes or have a minimum distribution. Well, it's still meaningful money your loved one that passed and gave you that account, they did that for a reason. And it was to benefit you. So that means we still want to grow those types of accounts. We still want to invest them for the long term.

If we're going to invest them for the long term, this 10 year period at least, we're going to look at this from the angle of, “Okay, we want this thing to grow.” So if we start off with, let's say $100,000 that you inherit, the very next year, you might've made a withdrawal and now it's down to $90,000, because we're taking about 10% per year. Well, but then we have a growth to consider there. So maybe it's actually $95,000 that’s still there.

What do we take? Do we take just the 10% based on the original value, which is still $10,000? Do we take another 10% based on the new value?

That part of the final [regulations] wasn't really clarified.

John Biedenstein: Yeah.

Colin Day: So, that's where there is some flexibility there.

The other thing to remember here is that if you inherit an IRA and somebody hasn't already been taking withdrawals from the account. For example, your father passes away, and they were 65 years old. They were below the age of the required minimum distribution, so they weren’t taking anything yet.

In that case, the loved one that inherits that – provided it’s a son or daughter just to keep that simple – that individual still has that 10 year clock. However, they’re not required to take anything out because the individual wasn’t taking anything out. So in this case, John, you have all the flexibility in the world. All the IRS cares about is that you deplete the account in 10 years.

John Biedenstein: Correct.

Colin Day: So talk about flexibility then. When you think about the different kinds of years that you might have, you might have a large bonus come to you one year. Maybe it doesn't make sense to take the withdrawal out of the inherited account that year. Maybe you are going to do big deductions because you're going to make big charitable donations, or you're selling property, or something like that that's going to complicate your tax life. This is a lever now that you get to decide how you're going to push and pull.

John Biedenstein: That's correct.

So you're going to coordinate it with your financial advisor and with your tax preparer to make sure you're doing these things and ultimately to minimize – It's a taxable distribution that's going to have to be made, but you want to minimize the taxes that come out of it.

Colin Day: Yeah. So pop quiz for you, John.

We've been talking a lot about pre-tax accounts right now. So these pre-tax, tax qualified accounts – thinking traditional IRAs, SIMPLE IRAs, your 401(k) through work, 403(b)s, governmental 457 plans, all those types of plans – they have this type of rule where we're dealing with the 10 years.

What about Roth accounts? What about my Roth IRA? Do I still have an RMD on those accounts?

John Biedenstein: Roth IRAs or Roth 401(k) contributions, at the onset you've paid taxes when you've made those contributions. So, the RMD required minimum distribution rules do not apply to Roth accounts.

So in that regard, it simplifies. And again, not that the government's implying things, but part of this legislation that we're seeing over time is really trying to make the retirement industry to [have] more Roth funding to get those taxes now, because they need them for all those different reasons.

In that regard, RMDs do not apply to Roth accounts.

Colin Day: Yeah. Inherited Roth accounts. Say your loved one, say your dad passes away and gives you, as the son or daughter, a Roth IRA. So now you have, what's known as an inherited Roth IRA. That account still does not have required minimum distributions, which is great.

However, the 10 year rule that we keep talking about, it actually still applies in this case. Because, again, the IRS doesn't want this money to just languish. They want you to take this potentially tax free account, take those dollars, and put them into the economy, spend them, which then spurs on economic growth, probably generate some sales tax and some other things like that.

So there is still a 10 year rule that is applied to that. But a strategy that you might want to think about if you're ever in that situation is to maybe not distribute the account over the 10 year period evenly, but rather just wait until the 10th year. And the reason is this inherited account does not have an early withdrawal penalty. Whereas if you do take from a Roth IRA, you could have a penalty, a 10% withdrawal penalty, for accessing the funds early. They are rules and other things we have to comply with there. But you might run into a situation where you owe more tax than you want to by taking money from your Roth IRA. Inherited Roth accounts don't have that penalty.

If you think about this and you're investing in this inherited Roth account that you've established upon the passing of your loved one. You're in a situation now where you get tax deferred growth in this account. You're not paying taxes as it grows over the 10 years. And if we know that you're not going to pay any tax on it nor penalties from this account, well, it makes a heck of a lot of sense to just leave the inherited Roth account alone and never touch it if you could for 10 years. And then in the 10th year post-death, you start to withdraw that. Okay?

So that's a more advanced strategy. Of course, your mileage will vary in terms of whether that's appropriate for you. But thinking about what the final [regulations] have finally given us is a little bit more courage as financial advisors to have these tax planning conversations with our clients.

And I will make the note, because John is a CPA, he's also our Chief Compliance Officer. What we're talking about today, of course, is not tax advice. We are tax planners at heart. And so if you have questions about this particular ruling, any information in regards to what you should be taking out on an annual basis, this is where your tax professional comes into play.

This is where we want you to talk to that individual to make sure that you're getting the right information so that you can make the best educated decision when it comes to tax filing.

John Biedenstein: Absolutely. And the other side is, we do a very good job reviewing tax returns of people to make sure – we're not saying somebody did something wrong or this or that, but just making sure that you're taking advantage of all the rules and regulations. Again, we're not providing tax advice, but we might [offer] suggestions that you then run through your accountant to say, “Would this be beneficial or not?” So it's critical that you share that process with us.

Colin Day: Yeah. I can give a couple examples of some prospective clients that have come to us recently. We brought in a CPA just to provide their two cents on their situation, because they didn't have one. In both cases, they found deficiencies in terms of their tax reporting.

And it wasn't because they were doing anything illegal or thinking that they were doing anything illegal. It's just, “Hey, that client did not know what they didn't know.” And so that's the kind of value that your tax preparer can provide, not just on the calculation of your minimum distributions every year, but also for all aspects of tax planning, along with your financial advisor.

John Biedenstein: I like the classification of efficiencies. It makes everything easier.

Colin Day: Exactly. Makes everything easier.

John, any last words before we let everyone go?

John Biedenstein: Again, this is very complex. It's a complex matter. It's changed over time. Some might have made different assumptions over the years. So check in with us, take advantage of us. We're a good resource to help you in regards to this confusing topic.

Colin Day: Absolutely. Well, I'm Colin Day. Thank you for joining us for another Capital Conversation, and we'll see you in the next one.

The opinions expressed in this program are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. It is only intended to provide education about the financial industry. To determine which investments may be appropriate for you, consult your financial advisor prior to investing.

As always, please remember investing involves risk and possible loss of principal capital. Please seek advice from a licensed professional. Correct Capital Wealth Management is a registered investment advisor. Advisory services are only offered.

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If you’re unsure about how RMDs affect your retirement strategy or want to explore your options for managing your distributions, feel free to reach out to us at Correct Capital. Our team is ready to guide you through these decisions and ensure your financial future is on track. You can schedule a meeting with a member of our advisor team, contact us online, or give us a call at 877-930-401(k). It only takes 15 minutes to understand if we’re a good fit.