Inherited IRAs Withdrawals – Strategy for New Rules in 2020

After reading this newspaper article about the 2020 tax rule changes, I came up with the following strategy for those who inherit IRAs. As I have always preached, Roth IRAs and 401Ks are much better than Traditional IRAs and 401Ks, but with the new rules, even Roth requires developing a strategy to handle the new changes in the law.

Starting in 2020, new rules concerning IRAs eliminate inherited lifetime “stretch” IRAs except for spouses and people who are less than 10 years younger than the deceased (for example a brother or sister within 10 years of your age). The old “stretch” IRAs required inheritors to withdraw annually for life from the inherited IRA (both Traditional and Roth IRAs) with the withdrawal amounts required each year based on their age.

The new rules, with the exceptions previously mentioned, requires IRA inheritors to withdraw the entire amount within 10 years. However, you do not have to withdraw the money every year, You are allowed to skip years, or withdraw it all in the 10th year – your decision. In both the old stretch IRAs and the new current rules, Roth withdrawals are not taxed.

Since once withdrawn from the Roth IRA, any of that withdrawn money re-invested in a non-IRA will be taxed as it grows – both dividends and capital gains, my advice is to withdraw money each of the required 10 years and then use those Roth withdrawals to reinvest to the maximum allowed into your own Roth IRAs and Roth 401Ks each year. Remember, since you are using tax free money to do this, unlike a regular Roth IRA deposit using your own “earnings”, this is like getting the tax free initial investment of a Traditional IRA and the tax free withdrawal of a Roth IRA – the best of both IRA worlds!!

If some of the inherited IRAs or 401Ks are Traditional, your mandatory withdrawals during that 10 year period will be taxed. So take the net after tax and invest them in Roth IRAs and/or 401Ks each year up to the government imposed limit allowed. There would be no additional tax, they will grow tax free, and the withdrawals will be tax free and not mandatory at age 72 as is the case with Traditional IRAs and 401Ks.

https://www.usatoday.com/story/money/2020/01/17/secure-act-stretch-ira-rmd-retirement/4488419002/?fbclid=IwAR1xLn_SrHzSGlZvp9OBNn4lJ1J5Od3T8tRohJy4YQ6mF8OPzGDDovTK0XQ

Taxes and IRAs and 401Ks – Don't be Fooled by the Government

The number one fact to always remember is that you are taxed on EARNINGS (and capital gains, interest, and dividends if you have any), and NOT what you deposit from your earnings into checking, savings, and brokerage accounts whether those accounts are tax deferred or not.

So whether you put money into a Traditional or Roth IRA and/or 401K, there is NOT a single penny of additional taxes due to the government.

Both Traditional IRAs/401Ks and Roth IRAs/401Ks have very different tax savings implications:

However, Traditional IRAs and 401K “tax savings” are a government “trick”or “shell game” that you want to avoid. Sure you get tax savings for the year you invest in them, but that's the trick that suckers you in. When you withdraw from those Traditional accounts (and the government forces you and/or your heirs to withdraw from them later in life), it will likely be decades later when they have doubled in size several times and thus are much, much larger than your initial investments. All of that money (original investment plus what it has grown to) is taxed. This is a great tax bonus for the government and a tax disaster for you, even if you are in a lower tax bracket when retired because there is so much more money subject to tax.

On the other hand, a Roth IRA/401K is a legitimate and very large tax savings for you. You paid zero extra taxes each year when you made deposits into those Roth accounts and you pay no taxes when you withdraw from those accounts, which likely have also doubled in size several times over decades, no matter how much money is withdrawn. Plus the government does not force the original owner to withdraw ever.

Now some employers offer Traditional 401Ks, but unfortunately may not offer Roth 401Ks. If there is a substantial company match to your deposits into those accounts, then given the fact that there is no Roth 401K alternative, you do want to take advantage of that opportunity.

For heirs to IRA and 401K accounts, the government forces you to make withdrawals even if it is a Roth account. You won't be taxed on the Roth account withdrawals, but you will be taxed on Traditional account withdrawals. My advice in either case, is take as much money from those forced withdrawals as the government allows or you can afford and reinvest it into Roth IRAs and/or 401Ks. Remember from above, it costs you nothing in additional taxes to do this, plus it saves you lots of taxes in the future as opposed to putting it in a Traditional IRA or 401K account or a non-IRA account.