Jeff Witz, CFP

Have there been any changes to how inherited individual retirement accounts (IRAs) must be distributed under the most recent legislation?

Last fall, we wrote an article about inherited individual retirement accounts (IRAs) and how they must be treated and distributed.

 As is the author’s curse, Congress changed the rules as part of the Setting Every Community Up for Retirement Enhancement (SECURE) Act. Under this act, no changes were made to the distribution rules if the person you inherited the account from died prior to January 1, 2020. The new rules only apply if the person died after that date.

Note: Due to the coronavirus disease 2019 pandemic, all required minimum distributions (RMDs) have been suspended for the remainder of 2020. If you already took an RMD from a retirement account, you can roll it back into your account before August 31, 2020.

Previously, if you were a nonspouse beneficiary of an IRA, 401(k), or 403(b) you could distribute the assets from the account 1 of 2 ways. You could distribute the entirety of the account no later than December 31 of the fifth year following the year the account owner died, or you could transfer the money into an inherited IRA and distribute the money incrementally based on your own life expectancy. The second option allowed you to keep the money in the account for years, staying invested on a tax-deferred basis without being forced to take the full balance. The IRS found this undesirable as it prevented them from getting their full share of taxes for many years.

Under the SECURE Act, a nonspouse beneficiary of an IRA must now directly roll over the assets to an inherited IRA and will need to withdraw all assets from the inherited IRA by the end of the 10th year after the year of death. For example, a beneficiary who inherits an IRA during 2020 would have 10 years to distribute the balance of their inherited account beginning on January 1, 2021, the year after the year of death, and ending on December 31, 2030. If the original account was a 401(k) or 403(b), the beneficiary can leave the assets in the plan, if the plan allows it, or roll them into an inherited IRA. Regardless of which scenario the beneficiary chooses, the same 10-year distribution rule will apply.

Forcing distributions to occur in a 10-year window means inheritors will need to carefully plan their distributions. If you wait until the deadline to distribute the full account, it is possible the distribution could be substantial and push you into a higher income tax bracket. Typically, spreading the distributions out over the full 10 years will result in the most favorable tax treatment, but you should consult with your tax professional before doing so.

Exceptions to the 10-year distribution requirement apply to assets left to an eligible designated beneficiary. Eligible designated beneficiaries are those who have a disability or chronic illness, those not more than 10 years younger than the decedent, or minor children of the decedent. These beneficiaries have the option to take RMDs based on their life expectancy.

When an individual inherits an IRA from a spouse, they can roll the assets into an IRA in their own name or transfer the assets into an inherited IRA. If the surviving spouse chooses to roll over the assets into their own IRA, then they would follow the regular RMD rules for their own IRA. These rules require RMDs begin once they reach age 72. If the surviving spouse chooses to transfer the assets into an inherited IRA, the timing of the initial distribution will be based on the decedent’s age at the time of his or her death. If the decedent was older than age 72, the surviving spouse must begin taking RMDs by December 31 of the year following the decedent’s death. If the IRA owner was younger than age 72 at death, the surviving spouse may be able to delay RMDs until the decedent would have turned 72.

If a spouse inherits a 401(k) or 403(b), they can keep the assets in the 401(k) plan (if the plan allows it). If the spouse is still working, they may be able to roll the 401(k) into their own company’s 401(k) if their company plan permits rollovers. As a final option, they can roll over the inherited 401(k) to their own IRA or an inherited IRA. Distributions would then follow the same RMD rules as if the spouse inherited an IRA.

1. Witz J. Inherited retirement accounts: What are your options? 

®. November 22, 2019. Accessed August 14, 2020. 

https://www.urologytimes.com/view/inherited-retirement-accounts-what-are-your-options

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Articles

Legislation sets 10-year withdrawal window for nonspouse beneficiaries.

How the SECURE Act affects inherited IRAs

It looks like my required minimum distributions in the future could be substantial. Is there anything I can do to reduce them before I reach age 72?

The IRS says that you cannot keep pretax retirement funds in your retirement account indefinitely; it mandates that you must start taking distributions when you reach a certain age. These forced distributions are commonly known as required minimum distributions (RMDs). Many physicians worry about the impact RMDs will have on their taxes in future years.

With passage of the SECURE Act in early 2020, the IRS now mandates that RMDs begin by age 72 instead of age 70½. The RMD for any given year is calculated by taking the account balance as of December 31 of the previous year and dividing it by a certain factor; this is found in the IRS’ published tables and is based on the age of the account owner. The RMD can also be impacted if a spouse beneficiary is more than 10 years younger than the account owner.

For example, if a 74-year-old physician has $500,000 as their 2019 ending account balance in their IRA, they must take an RMD. That RMD is calculated by taking $500,000 and dividing it by 23.8 (found on the IRS Uniform Lifetime Table). The result is $21,008.40—the amount the physician must distribute from their account in calendar year 2020 to satisfy their RMD. If a physician has multiple pretax retirement accounts, they must aggregate all the account values together to determine the RMD amount across all accounts. The entire RMD can be distributed from 1 account or from multiple accounts: It doesn’t matter as long as the full RMD amount is taken.

Any time you make a distribution from a retirement account in which pretax dollars were contributed—a 401(k), 403(b), 457, traditional IRA, or any other—you must include that distribution amount in your income and pay income taxes on it. Depending on your tax rate that year and the size of the distribution, the tax hit can be substantial.

Therefore, many physicians look for ways to reduce their RMDs before they are required to start taking them, and among the most effective methods is a Roth conversion. When a physician retires, they typically have a decline in income and thus fall into a lower tax bracket. Their income needs are often satisfied by drawing from their savings, Roth accounts, and smaller distributions from their retirement accounts if they are over age 59½. This presents an opportunity to make additional distributions from their pretax accounts in the form of Roth conversions.

A Roth conversion is when you take an amount from your pretax account, convert it to Roth dollars, pay the applicable taxes, and transfer it into a Roth account. Roth accounts do not have RMDs since the money has already been taxed. These funds can continue to grow tax free and are distributed tax free when a need arises.

Many physicians can distribute amounts from their retirement accounts that satisfy their retirement income needs and have room left over to convert additional amounts without putting them into a higher tax bracket.

Here is an example of how that works: A 65-year-old married physician needs $120,000 of annual pretax retirement income. Through distributions from business interests, investment properties, and pretax retirement accounts, they can generate the income they need. This $120,000 of income places the physician in the 22% married, filing jointly federal income tax bracket. This federal tax bracket spans from $78,951 to $168,400 of income. This physician can then convert an additional $48,400 ($168,400 minus $120,000) from their pretax account without it bumping them into a higher tax bracket. However, for practical purposes, they will want to convert a little less and leave themselves a cushion in case their math is not perfect. It is critical not to get it wrong and end up in a higher tax bracket.

By completing this process, a physician can reduce the balances in their pretax retirement accounts and in turn reduce their RMD obligations once they turn age 72. The money will still grow in a tax-advantaged Roth account, and it will place them in a more flexible tax position in the future.

Due to the precision required to convert appropriate amounts, we highly recommend you speak with a CPA and financial advisor to make certain the calculations are correct.

Converting funds to Roth dollars is among the most effective strategies.

The business of urology: Reducing required minimum distributions in retirement accounts

I am looking to retire next year at age 60, but I don’t want to take Social Security until age 70 when my benefit maxes out. What is the best way to bridge the income gap between when I retire and when Social Security kicks in?

It is common for individuals or couples who do not “need” Social Security immediately to delay taking their benefits to maximize payouts. To do this, they need to find ways to fund their lifestyle while they wait to reach age 70. There are many ways you can fund this income gap, and some are more effective than others.

Taking Social Security at different ages changes the benefit amount paid out to you. Normal retirement age depends on the year you were born but currently falls between ages 65 and 67. If you claim Social Security at your full retirement age, you are entitled to 100% of your Social Security benefits. However, you can choose to claim your benefit before your full retirement age at a reduced amount, or you can delay claiming your benefit beyond your full retirement age and receive greater than 100%.

The earliest someone can start claiming their benefits is age 62. If you start claiming benefits at age 62, your benefit will be reduced to 75% of your entire monthly benefit, assuming a full retirement age of 66. In other words, you will get 25% less income per month. Claiming early is usually only advisable in situations of financial hardship, when a stream of income is needed immediately.

The longest you can delay past your full retirement age is age 70. For each year you delay taking your benefit, you will increase your eventual payout by 8% compounded. Delaying claiming your benefit from your full retirement age until age 70 can significantly and permanently increase your Social Security income and financial security. By delaying from full retirement age 66 to age 70, you can increase your Social Security benefit to 136% of your normal retirement age benefit.

Waiting until age 70 to claim your Social Security benefit is no easy task, but there are some ways you can bridge the income gap created by delaying:

 Many physicians slowly phase themselves into retirement. Would your employer allow you to work reduced hours or, if you own your own practice, can you reduce your workload? Looking for a new challenge? Explore new fields of interest. A 2009 study found that people who pursued post-retirement bridge employment in their previous fields reported better mental and physical health than those who retired fully.

This is straightforward. If you have cash saved up beyond your emergency fund, using this cash to fund your lifestyle can be an effective strategy.

Make withdrawals from pretax retirement accounts.

 Social Securitymay be a taxable benefit. You may need to include it in your income and pay taxes on it. By delaying, you have less income, which may result in you being in a lower tax bracket. You can then make distributions from your pretax retirement accounts, such as 401(k)s and traditional individual retirement accounts, while minimizing the tax impact. Additionally, with these pretax accounts, at age 72 you will be required to start taking required minimum distributions (RMDs). This is when the Internal Revenue Service forces a percentage of your balance to be distributed. In some cases, this distribution can amount to substantially more income than you need and potentially push you into a higher tax bracket. Lowering the balance of these retirement accounts during this income bridge period can reduce the size of RMDs later that may otherwise put you in an inconvenient position.

 If you have an investment that has lost value, you can sell that investment to capture the loss. You can then use that captured loss to offset gains in another investment that you sell. Not only is this good tax management, but the two sales will also generate cash you can use as income.

Overall, delaying Social Security can lead to a significant increase in benefits and can provide an extra layer of long-term financial security. To bridge the income gap this strategy creates, you will need to be smart about how you generate cash to maintain your lifestyle. Some of the techniques we discussed take significant planning to execute correctly. For this reason, we recommend you consult your financial advisor or tax professional before taking action.

1. Wang M, Zhan Y, Liu S, Shultz K. Bridge Employment and Retirees’ Health: A Longitudinal Investigation. 

The information in this column is designed to be authoritative. The publisher is not engaged in rendering legal, investment, or tax advice. If you would like assistance with your individual investment strategy, please email witz@mediqus.com.

Withdrawals from pretax retirement accounts are among the ways to bridge your income, according to Jeff Witz, CFP.

How to fill the gap between retirement, Social Security

Given the market volatility lately, I’m questioning my investment strategy. Is there a preferred approach to follow when investing?

Over time, economic and political climates change, causing investors to question their current investment philosophy. We are certainly in 1 of those environments right now. Physicians, like all investors, constantly strive to achieve attractive returns in their portfolios and grow their financial assets over time. By accomplishing this feat, investors find that their portfolios, whether earmarked for retirement, college education, or other objectives, can be working for them instead of them needing to work harder to save more. This is especially important in an environment where incomes may be declining.

Although the perfect investment would have the attributes of high growth with little or no risk, the reality is these types of investments don’t typically exist. Throughout history, investors have spent significant amounts of time developing methods or strategies that come as close as possible to that “perfect investment.” There are many investment strategies, but none is as popular or compelling as modern portfolio theory (MPT).

Developed by Harry Markowitz and published under the title “Portfolio Selection” in the 1952 

, MPT explores how risk-adverse investors construct portfolios to optimize returns in relation to the risk of the underlying investments. The theory measures the benefits of diversification-not having all your investment eggs in 1 basket.

Although developed in the early 1950s, recognition for the achievement was delayed because the task of applying MPT was only made possible using modern computers that could handle the vast number of calculations and the range of historical data needed by the model. In 1990, 38 years after he wrote the article while teaching at the University of Chicago, Markowitz was awarded, along with fellow academicians Merton Miller and William Sharpe, a Nobel Prize for what has become the most widely used strategy for portfolio selection.

For most investors, the “risk” they take in an investment is that the return will be lower than expected. In other words, it is a deviation from the average return. The MPT model calculated for each investment a “standard deviation” from the mean that the model calls “risk.” What they found was, through diversification, the “risk” of 1 investment may offset the “risk” of another. The key behind the MPT model is determining which combination of investments in a portfolio provides the “maximum return and lowest risk.” Using a tool called the Efficient Frontier, the MPT model looks at desired rates of return and displays the combination of investments that produces the optimal level of return and risk based on past performance of the various investment markets. Although the past is not always a predictor of the future, MPT uses those data to estimate various risk/return scenarios.

The key today to using MPT is understanding that different “asset classes” have different levels of risk and combining investments from different asset classes in a measured way gives the investor the greatest probability of achieving their rate of return objectives while minimizing risk as much as possible. Examples of major asset classes include large US companies, small US companies, international companies, domestic bonds, international bonds, and real estate. How well an investor assigns different amounts of their total investment portfolio to these asset classes and how well that distribution across asset classes applies to their investment objectives, is the biggest determinant of long-term investment success. In fact, Markowitz’s study found that more than 90% of your long-term investment success is determined by asset class selection.

Funding the various asset classes can be easily accomplished through indexed mutual funds or indexed exchange traded funds (ETFs) that mirror a specific index or asset class. Even after all these years, and a number of bull and bear markets and new investment vehicles, MPT continues to play a crucial and meaningful role in investment management strategy.

An indexed mutual fund or indexed ETF is a fund that seeks to mimic a particular index. An index such as the S&P 500, which tracks the performance of approximately the 500 largest companies in the United States (large cap asset class), does not actually invest in these companies, nor can you directly invest in the index itself. Therefore, fund companies create mutual funds or ETFs that mimic the index. It invests in the companies contained in the index and in the same percentages the index uses to track performance. By investing in these funds, you can easily invest in an entire asset class. Finding an index fund for each asset class can help you achieve the asset class diversification that is a key pillar to MPT.

The information in this column is designed to be authoritative. The publisher is not engaged in rendering legal, investment, or tax advice.

"[A study by Harry Markowitz] found that more than 90% of your long-term investment success is determined by asset class selection," writes Jeff Witz, CFP.

Author | Jeff Witz, CFP

Articles

How the SECURE Act affects inherited IRAs

The business of urology: Reducing required minimum distributions in retirement accounts

How to fill the gap between retirement, Social Security

How modern portfolio theory can help meet your financial goals