Intro
Hi, I’m Cathy Curtis. Welcome back to the Financial Finesse podcast. And if you’re a new listener, welcome. I am this podcast’s host and also an acting and working financial advisor. My firm, Curtis Financial Planning based in Oakland, is an independent firm. And the firm is unique because we specialize in the unique needs of women—particularly women who take the lead in their household finances and are looking for a fiduciary financial partner to help them with their current finances and to secure their future, so they get more enjoyment out of their money today.
In this episode, I interview Megan Gorman, Founder and Managing Partner of Chequers Financial Management, a high-net-worth tax and financial planning firm in San Francisco. An attorney by training, Megan is passionate about the problem-solving required to work in the world of complex financial planning. She is also a senior contributor at Forbes and writes on personal finance and income tax.
As you listen, you won’t be surprised to hear that Megan is an adjunct professor at Golden Gate University in San Francisco as well. She is a very clear communicator and a great educator. And I’m happy to call her a friend, too.
Megan’s expertise is invaluable for today’s topic, inherited IRAs, which is why I’m so excited to have her on the podcast. Specifically, we’re talking about how the SECURE Act of December 2019 changed the rules for certain beneficiaries of inherited IRAs, creating a potential tax headache for some, unfortunately, including tax rates possibly jumping in the years the inherited IRA’s being distributed, and the fact that if you don’t follow the rules, you could get hit with a 50% penalty tax. No thanks.
I think everyone can benefit from this info whether you have an IRA or expect to inherit one. Many who are affected will want to review their current estate plan to ensure it’s still the best plan for all involved. We cover a lot, and it can get dense. So, if you have specific questions about after listening, please don’t hesitate to send me an email. And as always check the show notes for more information and resources related to this episode. You can find more information about me and my firm at curtisfinancialplanning.com. I hope you enjoy the podcast.
[03:30]
Cathy: Hi, Megan.
Megan: Hi, Cathy. How are you?
Cathy: I’m great. Welcome to the Financial Finesse podcast. Thanks so much for agreeing to come on as my guest.
Megan: Oh my god, I’m so excited to be here. I’ve watched a few of your episodes and they’re really, really informative. We can talk about some interesting stuff with IRAs.
Cathy: Oh, we certainly can. Believe it or not, there’s interesting things about IRAs. I first wanted to say where I first noticed you was on a Citywire cover in about 2019. You were profiled, and I was so impressed. And you’re in my area—you’re in the San Francisco Bay Area. And I thought, why haven’t we met yet?
Cathy: And one quote that I really related to, I’m just going to read it real quick. “The thing that I’ve had to get comfortable with over the course of my career is that being a woman with a strong sense of ambition and a strong personality, the best system for me was one that I created on my own.” And I so related to this, because I founded my own firm, and I know you founded your own firm, Chequers Financial Management. And I know it was hard in the beginning, but you’ve been doing it for six years now, is that right?
Megan: We just had our sixth anniversary. Yeah.
Cathy: That’s great. Congratulations.
Megan: Sometimes I wish I’d done it earlier. When you made your career transition from marketing to finance, you just jumped in. And I love that sense of courage and how you took on your practice. Because I think a lot of what we do on a day-to-day basis with clients, is really try to give them the confidence to jump in and embrace their money and embrace what they do.
Megan: It’s hard. It really is. I mean, when people ask me what I do, I often say, look, a lot of times, I’m doing a lot of coaching. I might know the technical rules, but it’s really about pushing you in the right direction for the answer that’s appropriate for you.
Cathy: And you know, that combo of having the technical skills and that other skill set of being able to listen and support is really powerful. And that’s, that’s really what we do as financial advisors. We combine those two things. And personally, I know on the technical side, you are a whiz. Because the other times I’ve seen you is when you’ve been on podcasts, explaining the CARES Act, and you have a really great way of making things understandable—very complex things, which most tax things are—very understandable. So that’s why I’m really thrilled that you’re here.
Cathy: Before we get going on the technical stuff, though, I wanted to ask you. So, Chequers Financial Management—and I know Chequers is the prime minister’s summer residence, right? I wanted to ask you this before. Is there a story behind you picking that name for your firm?
Megan: Yeah, so I’m a British History major, and always focused on the history of England. And when I went to name the firm, I wanted to pick a name that had a couple of meanings. So the term Chequers, the Chequers House was built in the 11th century in England, it was the Chancellor of the Exchequer, his house, the CFO. And for 800 years, it passed through family wealth transfer. And then at the early 20th century, men were starting—and unfortunately not women—but men were rising in society, self-made men, and they needed a place. You know, originally, the country had been ruled by the aristocracy. And they needed to have a place where they could entertain and do business. So the last owners of Chequers House donated the house to the country, so that self-made men would be able to do business. So, it’s an intersection of family wealth and self-made wealth,
Cathy: Right.
Megan: It’s interesting, when you have a firm, you start to attract a certain type of client. And so my, a lot of my clients—not all of them, but I would say that 85% of them—are self-made. I don’t know if it’s because of, you know, my own background. I love stories like that. But I’ve always found the clients I’m working with tend to be the first generation with sizable wealth.
Cathy: Oh, I love that. And so that’s why you named the firm Chequers. It completely fits. And I have to tell you, we have something else in common. I wasn’t a British History major. But I was fascinated by British history when I was younger, and I read everything I could about it. So that’s so cool. I’m really glad that I asked you about that.
Megan: Yeah, no, I love British history.
[08:11]
Cathy: Okay, so let’s get down to talking about the technical stuff. So, the reason I want to talk about the inherited IRA, specifically, is because I have a lot of clients who are inheriting IRAs and/or are growing large IRAs that they are going to give to their heirs. And I’m beginning to realize—you know, the SECURE Act changed the rules about distributions starting January 1, 2020—and that this needs to be paid attention to. Because of the changes, tax bills could really go through the roof. And there are things you can do to mitigate. And I thought, who can I talk to about this? You came first in mind.
Cathy: And so, we’ll start with the basics, so everybody understands where we’re going. Let’s start with what is an inherited IRA? What changed? And we’ll go from there.
Megan: Yeah, so a good place to really put this in context of why this is becoming such a big issue for a number of Americans is, pre-pandemic, Fidelity did a study. And they found that over, I think it was close to a half a million Americans, have IRAs that have balances in excess of a million dollars. Now, they were just doing a study, but put into context is the fact that this is a big issue.
Megan: And so, you know, an IRA is an individual retirement account, whether it’s your traditional one or a Roth IRA. And when you put money into the account, you’re saving it for your retirement. But the thing is, most people don’t spend their IRA down to zero. And so when they pass away, it passes to a beneficiary. And so that’s what we’re talking about here, is when you have your IRA, passing it to the beneficiary, they are inheriting an IRA. And that’s sort of the tricky part of planning. And why I say that is, when we think about estate planning as a whole, we think about our assets—our houses, our brokerage accounts, our jewelry, our cars, things like that. But one of the biggest assets that most people pass on to their family members or friends, and so on, is their IRA.
Cathy: So true.
[10:28]
Megan: The planning you do with your IRA is key. Now, if we go back to before the SECURE Act, and it’s funny, because the SECURE Act came into being in December of 2019, so less than 15 months ago. But truth of the matter is, it feels like a lifetime ago because of the pandemic.
Megan: And it made two really important changes to IRAs. The first is it changed required minimum distributions, the age at which you must take your distribution from your IRAs. It was at 70 ½, and it moved to 72. So that was the first thing it did. The second thing it did is it eliminated this concept called a stretch IRA.
Megan: So, what was the rule before? So basically, let’s say, Cathy, I had an IRA, and I named you my beneficiary, and I passed away, and you inherited my IRA. Before the SECURE Act, you could do something called a stretch IRA, which is, you would be leveraging the IRA tax deferral by just taking the IRA required minimum distributions. You’d take it out over a long period of time, stretching out that IRA. And so, if you lived another 40 years after I passed away, you could be taking distributions over those 40 years if you handled the IRA correctly.
Megan: Now, Congress didn’t like this. And the reason they didn’t like this is Congress wants to get paid. And if you think about it, with an IRA, we put money in pretax, it grows tax deferred, and when you get the distribution, you pay ordinary income tax on it. And so if you inherited my IRA, and you lived another 40 years after I died, right, you might not be paying all the income tax till 10, 20, 30, 40 years after I die. And Congress was like, well, that’s not cool. That benefits rich people.
[12:36]
Cathy: That is so not true, it just blows my mind. Because everybody, like you just named that stat about IRAs. In America, it’s not only rich people.
Cathy: So, you know, I want to give an example. I talked to a client today—just to talk about what you’re saying, to illustrate it—he’s going to inherit, he’s going to split it with his brother, a $500,000 IRA. Under the old rules, he would have to take about $18,000 a year.
Cathy: Under the new rules, he’s going to have to take about $50,000. Although you don’t have to take it each year, you could take it—well, you’ll get into that. But if he did take it each year, it would be $50,000. So think about the difference between $18,000 and $50,000 in tax, and also adding that on to your other income, what’s it going to do to the tax bracket you’re in, etc.
Megan: So I mean, and that’s the—you’re hitting the nail on the head. So that’s what the big change is. So the law was previously, you could stretch it out. And it was, I thought it was a great thing for a lot of Americans because it gave them measured income, like in your example, where the $18,000 a year.
Megan: So Congress changes the rule. And after January 1, 2020, the new rules apply. So for anyone who had an IRA that they inherited pre-January 1, 2020, old rules still apply. People who got, who were now going to inherit after January 1, 2020, what Congress did is basically what you’re talking about. They’re saying, except for a certain group of eligible designated beneficiaries—which we’re going to get into in a moment—everybody else who inherits has to inherit and take the money out over 10 years. They don’t care how you take the money out over 10 years, but 10 years after the date of death, IRA has to be done. U.S. government has to get its money and be paid its taxes.
Cathy: And that is a difference. Before it was a required amount every year. So the difference is now they’re not requiring you to take out an amount every year, you have to just empty it by the 10th year.
[14:54]
Megan: Correct. And so one of the things that’s going to be really key here, right, is the fact that, you know, you need to think about who your beneficiaries are going to be. Because this 10-year rule applies to a lot of beneficiaries. But there are a group of beneficiaries that Congress and the IRS have excluded from the new rule, okay. And so it’s really important to focus on this.
Megan: So the first group, which is sort of obvious, is surviving spouses. So if I have an IRA, and I walk outside, and I get hit by the proverbial bus, and my husband inherits the IRA, he can still draw it out over his lifetime. In fact, spouses have two ways to take a distribution from an inherited IRA. The first is, my husband could step into the shoes of me and withdraw the balance over my life expectancy. Or he could just roll it into his IRA and get sort of a fresh start with it.
Megan: Okay, so for spouses nothing has changed. And that’s important here. Because for a lot of people out there with their IRA planning, the original beneficiary, the primary is going to be their spouse, and the rules are the same. It’s going to be on the contingent side. But let me give you the other groups of people that are given sort of this special designation now. Eligible designated beneficiaries, EDBs.
Cathy: EDBs, let’s call them that from now on.
Megan: Okay, so EDBs. We’ve got the surviving spouse. We’ve got the IRA owner’s children, or child, who are under age 18.
Cathy: Minors.
Megan: Yeah. Just to give you more clarification, if I had a child who was 13, and I named them as my beneficiary, and I walk outside and get hit by the proverbial bus, they could inherit my IRA. And they could stretch it until they hit age 18. And then the 10-year rule applies.
Cathy: Right. And it does depend on the age of majority in the state, right? In some states it’s 21, and that would be the date then. Is that true?
Megan: You know what, I believe it’s 18 because this is federal law. So I don’t think there’s anything different about that.
Cathy: Okay, good to know.
Megan: Now, keep in mind, if you’ve had a grandchild, they do not come under the child provision. So this is child only. The other groups of EDBs are disabled individuals, chronically ill individuals, and any individual who is not more than 10 years younger than the deceased. Okay. And really, that is siblings. Okay. They’re trying to say siblings without saying siblings.
Cathy: Or parents. But that wouldn’t make any sense for a lot of reasons.
Megan: No, because they’re not 10 years or less in age, unless the parents are really precocious.
Cathy: Right.
Megan: So, if you think about it, right, it’s a very specific group. And the two groups that make the most sense, right, are the disabled and the chronically ill. Because if you think about it, they’re trying to add protection there. The major groups—surviving spouse, child under age 18, and an individual who is not more than 10 years younger—you have to really think about this group. The group is a very small group of people.
[18:22]
Megan: So I think the thing that we’ve got to be thinking about here is, how do you want your estate plan to flow? Right? Because what I find when we do estate planning is we do a nice little flow chart when it comes to the will or the trust here in California, right? How it all will pass, how will the assets pass. But I think the beneficiaries, right, you need to be doing the same thing.
Megan: So for instance, if I was to take my situation, I would look at my situation holistically. And I don’t have children. But I have two brothers. One is two years younger than me, and one is eight years younger than me. And in my estate plan, I do want them to have some of my assets. But if I was to look at the whole thing, right, to look at my entire asset base and figure out—how am I going to slice up the pie?
Megan: And I know I want to give a piece of the pie to my two siblings, and I know that they’re less than 10 years younger than me. What I might do is say, well, because they can stretch it out, I might name them as my contingent beneficiary to my husband. Because they can still take advantage of these stretch IRA rules, right? Other people in my estate plan, right, like my mother, my best friend, some of those groups, right, they might not meet the stretch IRA definitions, and they might be better served taking under my estate plan.
Cathy: Right.
[19:45]
Megan: I think the thing is, and I know Cathy, a lot of people who listen to this are, you know, clients of yours and also advisors. I think that given the changes in the law, the first step everybody really needs to make is pull it all together holistically between the estate plan and the beneficiary designation. And really think about mapping assets.
Cathy: And let me let me stop for a second because I think I want to clarify something. So, for the listeners, when you’re talking about the beneficiary designations of the estate plan, the estate plan includes anything that isn’t an IRA with a beneficiary or a life insurance policy with a beneficiary. It’s your taxable assets, your house, things like that. But those are the things that go in your trust. And then on the other side is the IRAs and the life insurance policies that have designated beneficiaries. So, Megan is saying you need to have a holistic plan to combine those two. Just explaining the term estate plan.
Megan: Yeah, no, I think that’s really helpful. And I think one of the things that’s happened over the past decade is estate attorneys have gotten more focused on beneficiary designations. So, you know, I think for everybody, right, the best way to look at your estate plan in general is that it’s a living thing. I always tell clients that this is living, breathing estate plan. And anytime there’s a life event, we should get back in front of the attorney, right? Whether it’s you’ve had a child or grandchild or you got married, all of those things bring us in front of the estate attorney. But the SECURE Act and the changes to the beneficiary rules is also a good point for us to then reach out to our advisors.
Cathy: That’s a good point.
Megan: This is the time that maybe we should refresh this. And I think one of the things that the advising community has gotten very good at is doing a whole balance sheet approach. So Cathy, I’m sure with your clients, you know all of the assets, even if you’re not managing it, right, and I think that’s so important. And I think the ability to go through the balance sheet and say, okay, this is covered by my trust, but this is covered by beneficiary designations is really important. Because I’ve always been surprised at times to realize that people don’t understand how powerful beneficiary designations are.
Cathy: They don’t, they don’t. And so are you saying that you think estate attorneys didn’t focus on that as much, and now they are helping clients more to figure out that holistic approach?
Megan: I think that they’ve always been helpful on it. But what I’m seeing more when I get client estate plans is there’s often a great letter or a summary in the front of the estate plan, and you probably see this as well. You know, saying look, retitle your assets this way, but also say, listen, for your beneficiary designations, this is what it should likely read. And copy that on there.
Megan: But here’s the thing. For a lot of Americans, right, naming the spouse followed by their children might be the easiest solution. But for people who have these very big IRAs, this is where you really have to get into the planning, get into thinking about how you want it to work and how it’s going to flow. Because things sometimes don’t flow the way you think they might until you map it out.
Megan: My first piece of advice here is, because of this change, it’s a great time to connect with your advisor. Go through the balance sheet, understand what goes by the trust and what goes by beneficiary designations, and then work with your advisors to refresh the beneficiary designations, to really, really look at them and make sure it makes sense in context to the balance sheet.
Cathy: Love that advice. Perfect.
Megan: So that’s sort of the first thing because the problem we have, right, is we get into a weird world of taxation. And, you know, I think one of the things that’s been so overwhelming for people is this idea that if they inherit an IRA, right. So if I inherit an IRA from my mother, I have to take out the distributions over 10 years. And it’s a complex rule, because I’m facing income tax consequences when that comes down the path, and it’s how do you manage that? Are there certain tricks out there or ways to think about it that will help you manage the tax piece of it?
[24:19]
Cathy: Let me interrupt for one second. And I totally agree that I want to go into the taxing. So, you’ve been talking about what the owner of the inherited IRA should do, right? And one of them is definitely look at the estate plan and look at the beneficiary designation as a whole. Before we get to the inheritor, the heir, the beneficiary, is there anything else that the IRA owner can do before they die, to reduce tax for their heirs? And is that a wise thing? Do you think that’s a wise planning move to do?
Megan: It’s funny you bring that up. I think that when you, one of the things that you have, as you build your asset base, you have to figure out is what are your priorities. So I have a large group of clients, that the priority there to mitigate taxation, regardless. They just want to make things easier for their children and grandchildren. And then I have other clients that sort of say, look, my spouse and I, we’re protected. It is what it is, whatever happens plays out. So I think there’s a little bit of developing a philosophy on what your priorities are in your asset base.
Megan: Now, if you are one who said, look, I want my kids and my grandkids to inherit. I don’t mind if I have to take some of the pain up front. Some of the things that they should be thinking about is, can you convert your traditional IRA to a Roth IRA? Now, what does that mean? So, as we said, a traditional IRA, you put in pretax money, it grows tax deferred and comes out as paid at ordinary income tax rates. Roth IRAs, you put after-tax dollars in, typically, I’m just giving the broad scenarios. The money grows tax deferred. And when you take your distributions, it comes out tax-free. So if you’re sitting on an IRA, and you’re looking at your beneficiary saying, I don’t want them to pay a lot of income tax down the line. I don’t mind paying the tax. I might convert my IRA to a Roth IRA. Meaning I might pay all the income tax upfront, so that the money in the account becomes a Roth.
Megan: That doesn’t mean we get around the stretch IRA rules, the 10 years. But what it does for your beneficiaries is they can keep them, you know, if you pass away, and your children who were over 18 inherit, the money can stay in the Roth IRA for 10 years growing tax deferred, and then in the 10th year, you can take it all out and therefore mitigated some of the income tax over time.
Cathy: And this is assuming that the person that’s Roth-ing their IRA can afford to pay the tax. That’s why it really depends on what your goals are with your money. Do you want to pay the tax for your kids or your heirs? Or can you afford to do that? Do you need the money to support your lifestyle or whatever?
Megan: Right. Now, I’ll tell you my own personal situation. I mean, obviously, I’ve named my husband. But I’ve named friends. And my attitude is, look, you’re inheriting this. So what you have to pay the tax? It’s more than you had, right, like you’re lucky to be inheriting it. And that’s my sort of personal philosophy on it. You know, you don’t have tax practitioner.
[27:53]
Cathy: You don’t have kids, though. I know I’m thinking of some clients in particular, if you explain this to them—what’s going to happen when their kids inherit. They’re going to go, oh, really? And so then I start thinking, this is the next thing to think about. Who’s in the higher tax bracket? The person with the IRA that might do the Roth, or the kids? Are they high income earners? So, it always gets very complex, these types of decisions, in the end.
Megan: It’s very specific to the to the personal situation. And I just want to add one more element to that. I had someone do this in 2008, during the crisis. But sometimes the best time to be doing this type of planning for whether or not you should convert an IRA to a Roth is when the markets are down. So a year ago right now, right? We were almost at, I mean, right now we’re in April. But last March, March 2020, markets at an all-time low there—that would have been a brilliant time to convert your IRA to a Roth. The thing you got to think about is timing matters.
Megan: So if you’re one of these people who are sitting there saying, look, I’m going to be passing my IRA on to someone who’s not a spouse, who doesn’t qualify as an EDB. And I want to make sure I mitigate all potential income tax for them. And I want to convert my IRA to a Roth, and I have the money to do so, I’d wait till the market dropped.
Megan: In 2008, I remember we did it. I think we did it in like January—it was like December of ’08, January of ’09—and the market, as you know, hit bottom on March the 9th, 2009. And today, we’re at all-time highs. In retrospect, it was a brilliant move because he paid the income tax on a very low amount. But at the time, it was sort of like, I remember him asking me if I lost my mind. And I was like, no, because if you believe the markets will rebound, which you know, I think a lot of investors do, you know, at this point, moving it to a Roth over time, right now, saves you tax dollars down the line.
Cathy: And if they invested it, if they invested it right away in the Roth, they got to participate in the recovery fully, you know?
Cathy: Yeah, timing is super important. I mean, you can’t predict what’s going to happen with that. But you can certainly watch and be ready.
[30:21]
Megan: I would make the argument, you know, part of our job right now is when the markets are on a tear, we need to be talking about planning ideas with clients for when the markets drop. So next time we have a March of 2009, or a March of 2020—weird that it’s always iin March—when those moments happen, you don’t want to be paralyzed in your decision making. You will have wanted to have thought this through.
Megan: So I would challenge you to say if we went back to where we were on March 27th 2020, which was the bottom of the pike, technically, the bottom of the market when the CARES Act was signed. You know, looking back now, do you wish you had converted your IRA to a Roth and paid those tax dollars on it, given the growth in your IRA? And these are the questions people have to ask.
Megan: I don’t want to lose track of the beneficiary designation. So if you’re an IRA owner, my advice is flowchart out how your IRA is going to pass. Remember, if it passes to your spouse, you’re still under the old rules. If your contingent is not in the group of EDBs, then you really need to think about that group. And think about what is your philosophy on taxation? Do you want to pay the tax for them? Or do you not? Do you even care? I mean, are you saying, look, you’re inheriting something. God bless.
Cathy: And there’s nothing there’s nothing wrong with that attitude, by the way.
[31:47]
Megan: Right. Now, the tricker thing is, the person who inherits it. So you know, we’ve been using a scenario, right, where if you inherited my IRA, Cathy, you’re going to have a whole host of decisions that you have to make when I pass away. Because you get told, okay, you’ve inherited an IRA, what do you want to have happen? And this is where, as the beneficiary, you really need to work with a tax professional or another advisor who can lay out taxation for you. And to sort of map out the next 10 years, what does it look like, right?
Megan: Because you might be working for the first five years of the 10 years. And the last five years, you might be retired, and so your income bracket might be changing. And so what you want to be doing is roughly mapping out where you think your ordinary income tax bracket is going to be.
Megan: Now, some people would say, look, if your bracket’s going to remain the same the whole time, you just might want to take a piece out every year, and so be it. Other people might say, look, wait till the very end, wait till the 10th year, and then take it all out.
Cathy: There’s the other factor that predicting tax rates, like, right now we have an administration who might raise taxes. So you have to think, will I be taxed at a higher rate later, in that 10-year time frame? Or should I take it now? That’s another thing to consider.
Megan: Because there’s also a third group, right, of people who are trying to, they might have a high tax bracket, then a low, then a high, then a low. And you can intersperse the distribution that way. But I think, what I tell people about retirement planning is—we talked about me being a history major—I think of things on a timeline. Seventy-two, as we talked about. If they start taking the RMD before 62, they might still be working, but 62 to 72 is usually that first sort of decade of retirement.
Megan: And what a lot of them experience in that decade of retiring is they might be taking Social Security, but a lot of their income might be coming from their investment portfolio. And they might be municipal bonds, which are tax-free, or qualified dividends at preferential tax rates. And that might be the sweet spot to pull down a lot of the income to fill in the gap.
[34:03]
Cathy: Let’s repeat that, because that’s a really important point.
Megan: Yeah, I mean, I think the thing is, when you’re working with your advisor, they typically do a long-term cash flow. I think it’s the best tool out there. And Cathy, do you use them with your clients?
Cathy: Oh, yeah, I do this kind of planning, where in that that period you’re talking about—where you’re looking at—right when you retire before you take RMDs. It’s a really critical planning time.
Megan: It is, and it’s where your income tax, you know, if you do that sort of long-term cash flow, you typically can see between ages 62 and 72, there’s a reduction in taxation. Because most people go from paying a lot of ordinary income tax to preferential tax rates, right? They have municipal bonds that are tax-free, they have qualified dividends, and they often have Social Security, but their brackets drop.
Megan: And that’s where layering in IRA distributions can be incredibly powerful because you’re going to get more money out, but at a lower tax rate. And where I think anyone who’s inheriting an IRA really needs to think through sort of when they take it, and when they can take advantage of certain tax rates.
[35:11]
Cathy: Yeah. Could you talk a little bit about the whole Medicare and IRMAA charge thing, too? Because that’s something else that people need to think about.
Megan: Yeah, so there is a surcharge for Medicare. And I always find it, you know, it’s frustrating, because people don’t expect it. Medicare will surcharge you if you make a certain amount of income on your Medicare payments. So that’s frustrating for people, because first of all, Medicare looks back two years on your tax returns. And they add back any municipal bond income that you had. They’re really trying to figure it out.
Cathy: You know, the point you just made is so true. Why does—no one knows that. Everyone thinks that it’s that bottom line, monthly Medicare fee. And it’s not. And people are always surprised that they’re paying more.
Megan: I was on a call with a client yesterday. And I mean, she’s now 71. And I’ve heard for six years about the Medicare surcharge, because they add back for muni bond income. Because she’s like, look, I did the right thing. I structured my asset base appropriately.
Megan: But I think the thing is, those are the nuances you have to add in. And look, I’m going to be honest, sometimes tax is tax. You can’t mitigate it. And if you can’t mitigate it, you want to think about all the other planning levers that are around you.
Megan: So, one of the big things out there—and I know you’re a big fan of it—are donor-advised funds. So if you’re going to have to take the distribution, either over 10 years, or in a couple of years, from an inherited IRA, you may choose to take the distribution in a year that you can make a donation to charity. Or fund a donor-advised fund, where you put some of the money right to charity and mitigate the tax bill that way. And that might be another way to handle it.
Cathy: Another point with the donor-advised fund is for the IRA owner, if they decide to Roth part of their IRA, is to do a donor-advised fund contribution in that year. That would mitigate some of the tax on that Roth conversion.
Megan: There’s not a one size fits all solution. There’s a lot of different options out there, and you have to work through them, depending on your personal financial situation, and who you are as a person. What are your values, your value proposition?
[37:32]
Cathy: It’s so important that you’re bringing that up. Because, you know, when I wanted to do this podcast, I was really focusing on how can we help our audience save, learn how to save tax, given this new rule? And the truth is that paying tax isn’t really the worst thing in the world, you know. You’re paying tax on income, so you obviously have income coming in. And it really does depend on your own personal philosophy.
Megan: Yeah. And, you know, I’m sure you use investment policy statements. And I think whether you work with an advisor or not, you should have an investment policy statement for your asset base that lays out the mandate.
Megan: And we try to put in ours what people’s tax philosophy is. So, you know, I’ve got things like they hate refunds—they don’t want the government having that loan from them—to do everything possible to mitigate income tax and estate tax issues. And it’s trying to find that balance. Because, you know, anytime we have a law change, it might close one door, but it opens another door. And what’s why you want to go down that path of doing that type of planning.
Megan: And I have a lot of clients who have very complex situations, and they do complex planning. And then I have another group of clients where they’ll say, there’s elegance in simplicity. I’m not going to overthink it. I don’t know where tax rates are going to go. I’m going to let my beneficiaries figure it out.
Megan: But the beauty of the changes in this rule here for beneficiary designations is both the IRA owner and the inherited IRA beneficiary all have planning choices to make. Everybody is able to control some of the controllables. And so, the thing is, when you inherit an IRA, what’s really, really important is to seek advice. To reach out, get help, because people like you and me, we’re trained in thinking through these parts of the problem and understanding in context of the bigger picture. That’s important.
[39:30]
Cathy: Yeah. And some real mistakes can be made, like the contingent beneficiary. I mean, there could be some huge tax owed if people don’t understand how the beneficiary thing works and who’s the eligible designated beneficiary and who’s not. Someone doesn’t take anything out of their IRA dies and then their beneficiary ends up paying tax on a huge IRA.
Megan: Things like that can happen. It happens all the time. And yeah, you know, these are in a weird way—if you inherit an IRA, it’s a bit of a champagne problem. It’s a good problem to have, right? You’re working through it. But I also would say to people who, to all of us who have IRAs and 401(k)s and 403(b)s, this is the cheapest estate planning you can do, right?
Megan: Because in California, when we do an estate plan, we have to go out and get a revocable trust. But beneficiary designation planning, if you set your beneficiaries up, and in five years, your life has changed. Maybe you were married and then you got divorced. Or, you know, you’ve determined that one of your children doesn’t need the money, but your other child does. It’s all about just changing a form. And that’s the thing I like about beneficiary designation planning. It’s quick and easy to fix.
Cathy: I have some of my clients with simpler estates use transfer on death beneficiaries for their taxable accounts instead of doing the trust for that very reason. Because it’s simpler.
Megan: Yeah, I mean, I’ll tell you here in California, you know, when you get your revocable trust, they’re like change your bank accounts. And I’m like, oh, God. The first time you go to the bank and try to do that, the practical aspect of it is difficult. People inherently like to procrastinate on this.
Megan: So like you do, sometimes I’ll say just make it TOD or POD account at the bank. It just makes it easier than getting into the trust, because it’s, it’s just, it’s difficult.
[41:34]
Megan: Now, I do want to mention a couple other planning ideas. Because, you know, one of the things that people talk about was with stretch IRAs, you were creating this unique estate planning tool for your beneficiaries. Right? So one other idea out there—and it comes with a cost—is the IRA owner can also choose when they’re taking their RMDs. If they don’t need the RMD to live off of, they can pay for life insurance, and that life insurance can then go to the beneficiaries of their death. And they don’t have to deal with this income tax issue.
Megan: And that’s one of the things out there that people are starting to use to replace it. It’s not my favorite technique, because I find life insurance at times can be too expensive. But if you’re really, really caught up in making sure your beneficiaries get a certain amount, and get it income-tax-free, life insurance is one of the levers you can pull in your financial picture to make that happen.
Cathy: Yes. Yeah, that is a little more complicated and more expensive. But again, it depends on the person. For the right person, that could be the best strategy.
Megan: And I think that’s the thing where, you know, the beauty of working with an advisor is our roles are to bring to the forefront things that we don’t want to deal with. We force conversations that people put off. And I think one of the best conversations we should be having—and we do have—with clients is how does this all flow? How does it all play out? And I found when I start to show clients how the estate plan flows out and the dollar amounts, it can sort of take them by surprise.
Cathy: Yeah. And they’re certainly not thinking about that. You know, who spends time thinking about these things? I’ll give a good example of another planning technique that just came up today around inherited IRAs. One technique to reduce the IRA before the person dies—and if they’re older, this kind of makes sense. If they’re taking their RMDs on a monthly basis, you may want to take the whole RMD as early as possible, just in case. You know, if they’re in their 80s or 90s? So that the money is out of the IRA.
[43:56]
Megan: Yeah. That could work. You know, and also, you could just choose to take larger distributions. You’re in your 70s or 80s. And your main sources of income are your IRA and your Social Security check, right? Maybe you start taking larger IRA distributions. I mean, there’s no harm in it. Again, work with your advisors to make sure from a tax perspective you’re not getting burned. But it might make a lot of sense for a lot of people, you know. And how to do and how to structure it.
Megan: I can’t emphasize enough, you know, tax planning—and I know Cathy, you use a tool with your clients that you have found really effective. But, you know, I agree. Planning is so key as you project ahead, because there’s power in that knowledge in trying to be tax efficient. I can’t tell you how many times people are like, “woulda coulda shoulda.” If I’d known that’s how it was going to play out tax-wise, I would have done this differently. And so working with advisors like Cathy, who have those tools, I think it’s so valuable.
Cathy: I do too. You know, I always do tax planning. But I tell you, it was a lot of work when you were using spreadsheets to do it. And there’s new software available to financial advisors that’s incredibly powerful where you could do scenario planning for years out. And, I find in my role as a holistic financial advisor where I do financial planning and investment management, and I know everything about the client, that is so helpful and powerful for them. And because tax accountants, I don’t do tax returns, and many accountants don’t know the whole thing. So it’s really good to have somebody that does to help you, especially with these kind of issues.
Megan: Because you can then say, look, even though we’re going to take a larger distribution, let’s donate to charity more. I know you’ve been doing more to your alma mater, right? Things like that. And it’s that little nuance there that can make the difference.
Megan: And I think it’s important to quantify the tax savings, right? And remind people when we’ve done a strategy—over time, what has that strategy added to your portfolio? It’s like, I told you the story of my client who converted his IRA in ’08, ‘09. I mean, here we are 12 years later. I mean that’s, for him, a seven-figure difference. That has value.
Megan: It’s painful paying the tax, but a certain point, you cross over where you’re winning. And that’s so important when we’re managing our finances is—you want, I want clients to feel smart and clever about the choices they made. And even if the choice is, like I’m saying, I don’t care if you inherit my IRA, and you pay the tax. Good luck. Have at it. That’s a proactive decision. You know, look. Ultimately, the SECURE Act, I think it hurts more Americans than it helps.
Cathy: Wait, wait, what does the acronym stand for? It makes me laugh.
Megan: Setting every community up for retirement enhancement.
Cathy. Right! How is this enhancing? I don’t see—it enhances the coffers of the government. I’ll tell you that, you know.
Megan: So, but here’s the thing. What if the opportunity had been different? That if you inherited an IRA, you had an option that it was, you know, it was almost like a pension to you. And you got to, you know, talk to an advisor, who explained this thing could be like a pension for the rest of your life. Don’t pull it all out.
Cathy: Yeah. Which it was. That’s really what it was. It was an excellent tool for people.
[47:36]
Megan: Yeah, I’m disappointed that they did this. You know, I think that unfortunately, we live in a day and age that when they’re setting tax policy, there is such a need to be punitive to people who have been financial success. Right? That sometimes the typical American, right, the average American who have worked so hard to save this money. And they’re sitting there, and they have five, eight, $900,000 in the IRA. They’re getting penalized because there are a few wealthy people that also got benefits.
Cathy: Right. You know, good point. Because we didn’t, we haven’t talked 401(k)s in relation to IRAs. But you said people have big IRAs. One of the reasons is they’ve been saving in their 401(k)s their whole life or their 403(b)s or whatever. And then they retire, they convert it to an IRA, and then someone inherits it. I mean, that’s the way a lot of, in some cases, that’s the only way people are saving money. So, it really is penalizing a broad swath of people in the United States, not just uber-wealthy.
Megan: It is. And you know, I think the other thing is it’s one of these things where there’s also planning that can be done while you’re building the wealth, right? So, I have a lot of clients where one spouse is working, and the other one doesn’t. And we still fund an IRA for them. And if we can, we convert it to a Roth.
Megan: And a lot of times we’re doing it because, you know, one, it gives us the chance to create a vehicle that’ll create tax-exempt income. But also, two, even though they name their spouse as the primary beneficiary, and maybe their children as the contingent, they also are making the decision that the spouse could eventually disclaim the IRA, the Roth IRA, if it’s inherited, and go right to the kids. Granted, the kids have only 10 years to take it out. But it’s tax-free money, right? It grows tax deferred.
[49:30]
Cathy: Okay, let me let me ask you something. I thought about this before we talked. If someone disclaimed an inherited IRA, and it went to EDB, would they get to take it over? I mean, they get to stretch it?
Megan: So, yeah. If it was an EDB, like if my husband disclaimed it and it passed to my brothers? Yeah, they can stretch it.
Cathy: Okay. That’s interesting.
Megan: That’s, that’s some of the nuances there. Yeah. I think you know, it’s one of these things where, know who you want to give to in your family. Right? How far out do you want to give? Nieces, nephews? You know, and you might do nieces and nephews in your actual trust, but you do your siblings in the IRA because of the stretch privileges.
Megan: And that’s some of the stuff you just, and you can see just even in this podcast, some of it is just sitting around and kicking the can around. If you have a beneficiary who has spending issues, you might be better served putting them in your trust, in your estate plan, your trust part of it, and not give them access to an IRA. But that’s also problematic.
Cathy: Right. They might drain it all in the first year, right?
Megan: Yes.
Cathy: Yeah. And you can set up trusts where they get the money at a certain time. And you can’t do that with an IRA. It’s their money.
[50:48]
Megan: The other thing is, when you’re the IRA owner, think about dead—I love the term from the law—dead hand control. How much dead hand control do you want on your beneficiaries receiving something? Because if you had two siblings, and one of your siblings had a drug issue or spending issue and your other sibling didn’t, you could say, look. I’m going to give you my IRA. You’re going to have to pay some tax on it, right, but you’ll probably be able to stretch it.
Megan: I’m going to give our other sibling money in the trust. And they might get less from the trust than you’ll get in the IRA, because net-net, you’ll get the same after tax. That’s the type of nuancing that you want to be thinking through.
Megan: And estate attorneys, financial advisors, CPAs—these are all great people to have the debate with. And, you know, sometimes get them all in one room. You know, get everybody in one room and say, look, I want to do my beneficiaries. And I really want to think through this. Let me tell you about all the people I’m thinking about, and what I’m concerned about with each of them, or what I’m not concerned about with each of them.
[51:51]
Cathy: Right. Oh, I have a question for you. Nondeductible IRAs. If someone’s eligible, even a very wealthy person, would do you do those?
Megan: Totally. And I file form 8606. Which records the basis and tracks it.
Cathy: Do you put it into the same IRA? You don’t do a separate IRA for the nondeductible contributions?
Megan: In general. I mean, I keep it in the same IRA. And it depends, because some of the people we’re doing it with have such large pretax balances that they can’t do a Roth conversion. But then I have a group that every other year, we’re funding it and doing the Roth conversion.
Megan: And look, I’ll say this for what I have found—and maybe it’s because I’m a woman—but I will often run into situations where, you know, the husband is the working spouse and the wife has stayed at home. And I think it’s incredibly important for women to have their own money. And it might not seem like a lot at first putting the $6,000, or $7,000 away if you’re over 50. But, you know, as I say, over 10 years of doing that, plus the growth, that turns into six figures pretty quickly.
Cathy: No, I agree. Spousal IRAs are—definitely. So, you take advantage of any tool that is out there, no matter how small. Like with the deductible IRAs, it’s only six or $7,000 a year, right. But then those earnings grow tax free. If you keep it in, if you keep it in the nondeductible IRA.
Megan: What I tell clients is, look, if there was $20 on the floor, I’d pick it up before I left the room. You know? Every little bit. Because if you max out your 401(k), and you fund your IRA, and then you add to your brokerage account, and maybe you fund your kids’ 529, and you add it all up, all those little things become a big number.
Megan: And we need to celebrate that more, because it is so hard to save today. You know, I always tell people, what’s fascinating to me is the government determined that upper middle class starts at income of, I believe, $127,000. That’s where the government feels like you should be set. And I’m sitting here in the Bay Area, and that is still tough living on $127,000. How do you save?
Megan: And the system since the 80s has been made to work against you. So, if you are a beneficiary of an inherited IRA, it’s a blessing. And you need to think through it because it can be one of those things that makes the difference between a financial challenge and a financial success over the long term.
Cathy: Right. Because it is a gift. It’s a gift, right? An inherited IRA is getting a gift, and you want to take care of it.
[54:39]
Megan: And you know from all those studies. You know, Merrill Lynch does a study every year on this, the focus is on family. And I believe what the study has found is that there are so many boomers and Gen Xers who are building their entire retirement strategy on inheriting because they can’t fill the gap and they’re all living so long. So, that’s the tough part.
Cathy: No, it really is. Well, this has been just as interesting and thoughtful as I thought it would be. You’ve given me some new ideas around this topic. I really appreciate you coming on. Is there anything else you want to add on the top? I mean, we could probably talk forever about this.
Megan: One last thing I would just say to anyone who’s doing this is engage in your planning. These are big dollars. Whether your IRA is $50,000 or $500,000. It’s big numbers, and you want to have some control on how it plays out, so really get engaged. And talk to your advisor. It’s well worth it.
Cathy: I agree. And so, let’s tell our audience where they can find you. I know you write for Forbes, and you probably do some other things. So please, yes.
Megan: So you can find me at Forbes at www.forbes.com/MeghanGorman. And then you can also find some of my other planning pieces at thewealthintersection.com. So you know, I love to do webinars and write about this. I think my role in this space is about helping people thrive. It drives my husband a little crazy, because we’ll be out and about, and I’ll be trying to give people advice. But I love this stuff, though. If you want to read my articles, feel free and feel free to reach out.
Cathy: And give people your Twitter handle for those that are on Twitter.
Megan: Sure. It’s @megan_e_gorman. So feel free to reach out on Twitter as well. But thank you for having me on. This was great.
Cathy: I want to do this again on another topic, okay?
Megan: You got it.
Cathy: To be decided.
Megan: You got it. Sounds good.
Cathy: All right. Take care.
Megan: Take care.
