Inheriting An IRA | What You Must Know And How To Plan For It | Retirement and Legacy

Troy Sharpe: This is a very important video for those of you that have money inside a retirement account and want to keep that money inside your retirement account for you, your family, and for many years to come.

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Troy: Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®), and host of the Retirement Income Show. About a year ago, the IRS passed what’s known as the SECURE Act. This act was designed to make retirement saving more accessible to more people inside company plans, and it had a few other things. The part that impacts you the most and when looking at this law in the long term impact that it has on your retirement dollars and your family legacy, you have to understand what the long-term intention is here from a tax standpoint.

We’re embarking upon what’s known as the Great Wealth Transfer. Approximately $68 trillion are inside retirement accounts, and that money will transfer to the kids and the grandkids of yourself and your peers over the next estimated 25 years or so. This is the greatest transfer of wealth in the history of the world. Prior to the SECURE Act, when your kids or grandkids inherited this money, they could stretch it out for 20, 30, 40, 50, 60, 70 years over the course of their life, incrementally taking distributions, which limited the amount of tax that the IRS received because that money would come out much more slowly.

The IRS said, “No. What we’re going to do now with this act is we’re going to force your children and grandchildren to distribute this money over a 10-year period at most.” This means the $68 trillion that’s going to the next generation over the next couple of decades, it will be forced out of retirement accounts, taxes will be paid on it, and they’re going to be paid at higher marginal tax brackets than they would have otherwise been. Let me explain, and also, let me talk about a couple of strategies that can help more money stay in your family for years to come.

What we have to understand is, first and foremost, 10 years fully distributed. If not, there is a 50% penalty on the amount inside the retirement account. Let’s say your kids or grandkids don’t understand the law or the rules, and there’s $1 million, $2 million, $500,000 inside that account, the IRS is going to get 50% of it as a penalty, then the rest must be distributed and paid taxes on. Now you’re talking 80%, assuming it’s a 30% tax bracket on whatever’s left. This could fully destroy a retirement account without proper planning, but I want to stress, a lot of this can be avoided and planned ahead of time.

We’re going to pay taxes and we have to pay taxes, it’s part of the deal. We made a deal with the government, we put this money in tax deferred, it grows, we take it out in retirement, we pay taxes at that time, but when we pass away, we used to be able to stretch it, now it must be distributed in 10 years. Let’s paint a picture here. You pass it onto your daughter, let’s say, and she’s married. They’re both working, they have joint combined salaries of $150,000 per year. You pass away, they receive a million-dollar retirement account.

They have to figure out how much to take out of that retirement account, what the taxes are, what the impact is, have the perspective to look ahead and do the type of planning that optimizes all these choices they have to make over the next 10 years, but the big one is, when do we take it out and how much do we take out? The way that tax rules work, the money that they take out over here will be on top of their existing incomes. If they have $150,000 combined salary and they take $100,000 out of here, that $100,000 goes on top, and it’s going to be taxed at the next highest marginal tax bracket.

Now we have a new administration that’s made it very, very clear that they are going to raise taxes. I’m not so concerned right now what the taxes are but, well, I do have concerns because obviously if this happens over the next couple of years, your children, grandchildren will pay a lot higher tax bracket. What will the taxes be in 5 years, 10 years, 15, 20 years? That’s more of a concern as we’re accumulating massive amounts of debt. We’re printing massive amounts of money to put into the economy in the financial markets as a form of stimulus.

How much do they take out? When do they take it out? What is that next marginal tax bracket that it will be taxed? 30%, 40%, 50%, 60%, I don’t know. Then state income taxes on top of that. What do we do? Here’s the problem. Obviously, if we do nothing and we just wait 10 years, this million might grow to $2 million if they forget to take it out. It’s a 50% penalty plus income taxes, so it can be a complete nightmare, but what do we do?

During your life, first and foremost, we should be looking at Roth conversions. If you’ve seen a lot of my videos, I’m a huge proponent of paying taxes now, because it creates tremendous problems down the road with required minimum distributions, IRMAA, which is a surcharge or tax on your Medicare premiums. It can possibly bump you up on your net investment income taxes. There’s tons of dominoes that can fall if we’re just letting that money defer and grow inside the retirement accounts. Roth conversions now. You need a strategy, you need a plan, you need something that looks at the long term, not just trying to save or optimize up to a certain bracket today.

One of the best ways, and this has been true for over 100 years, to pass the money on is through a concept known as using pennies to buy dollars. This is looking at certain types of life insurance. Life insurance, we put a premium. We’re talking cash value life insurance here not term life, because term expires. Cash value life insurance, permanent life insurance is an asset. You can have access to that money, it can be growing, you can actually access it tax free once you put it in.

Here’s just one example of how we can use pennies today to buy dollars for tomorrow. Let’s say we take $50,000 a year out of our IRA. We’re going to pay taxes on that. We do that for five years, it’s going to be $250,000 we take out. That still leaves $750,000 inside the retirement account. Now we have $250,000 inside this cash value life insurance policy. Depending on your age, your gender, your health, you’re going to have a death benefit immediately day one. You make that first deposit of $50,000, somewhere between $600,000 to $1 million, 100% tax free.

Now, depending on how long you live and the type of policy, there’s variable life, which I recommend you avoid, because it’s risk and there’s often higher fees and we want to stay away from variable outcomes when we’re looking at our more secure strategies in retirement. You have whole life policies, and you have what’s known as indexed universal life policies. I did a whole series on LIRPs, life insurance retirement plans, that can introduce you to some of the basics on the YouTube channel about some of these LIRPs or indexed universal life insurance policies.

Long story short, we put the money in over a series of years, it creates an immediate death benefit somewhere in between this range is a pretty good estimate, and it grows. Not only does the cash value inside these policies grow, but the death benefit grows as well. I’m putting ranges here somewhere between $800,000 to $2 million, depending on of course how markets do into the future and how the policy is structured. You want to make sure you work with somebody who knows how to structure these policies. To clarify something here, I said we want to stay away from variable policies, but then I’m talking about, well, we can put it in the market and make it grow.

One big distinction here, the variable universal policies have risk. They can go down when the market crashes. Indexed universal life policies and whole life policies do not lose value when the market crashes. They go up in IULs, indexed universal life. They go up when the market goes up but then those gains are locked in, they can never be lost. Market loses 50, you lose zero ,so we have a base, a foundation. The principal is protected from market losses. Those are the types of more secure strategies we want to look at if we’re trying to offset this.

Now, what happens? We have, let’s say the policy, you put the policy in place, you have $1 million death benefit, and it grows to $2 million when you pass away. Life insurance always pays 100% income tax free in 99.9% of scenarios unless you’re trying to take a tax deduction for the premium you’ve paid or you’re using it for some type of corporate purpose and you’ve gone awry of the tax law. 99.9% of life insurance policies will pay out tax free, the death benefit.

All we did was take $250,000. Here we go. $250,000 out of the IRA. Now that $750,000, it’s been growing as well, so now we’ve passed on much greater amount of money. A large portion of it is going to be tax free, let’s say somewhere between $1 million to $2 million, which the kids or grandkids can use to pay those taxes. Of course, we have a plan. We want the kids involved in this process to understand what to do. Now, we’ve essentially used pennies, that $50,000 for five years, $250,000, to eliminate this problem, this potential tax nightmare of 50%, 60%, 70%, 80% with the penalty of that IRA being vanquished.

Other strategies we can employ here, but these are some of the most common and time-tested approaches that have been used by the most successful families for years and years and years. I’m talking about the Rockefellers, Walt Disney, the Kennedys. This is a very, very time-tested approach to passing money on in a very efficient manner. One thing I did not touch on here, is the estate tax law. I don’t want to get too complex in these videos because the tax code is tremendously complex, but I’m just talking about income taxes here.

The new administration and future administrations, I’m sure, they want to reduce the amount of money that you can pass to the next generation tax free. They not only want to pay income taxes, your children to pay income taxes on it, but they also want estate taxes. If all of this is set up properly, you can avoid all estate taxes, all income taxes, but you have to have a plan, you have to be thinking ahead. You can’t just go about this and say, “You know what? It is what it is.”

We have to be planning. That’s what our Retirement Process process is about, that’s what these videos are about, and that’s what this entire channel is about, is to help you make better decisions with your money. First, you have to be aware. You have to be aware of some of these obstacles that are out there. Make sure to like this video, hit the subscribe button, and share this with a friend or a family member, maybe somebody you work with, and stay tuned to the channel because we’re going to continue to bring you excellent content in the new year.

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