Take Back Retirement
What Women Need to Know About IRA’s, with Sarah Brenner
Today’s guest is Sarah Brenner. Sarah is the Director of Retirement Education at Ed Slott and Company. She truly is an expert in IRAs—Individual Retirement Accounts—which for so many of us form the crux of our plan to save for retirement. But best – she knows how to explain the complicated stuff clearly.
Listen in and learn the key things women need to know, especially after widowhood and divorce. We’re talking best practices, long-term benefits, and common pitfalls regarding both traditional and Roth IRAs.
Most of us think IRAs are pretty simple: you put money in and take money out. But in reality the rules are very detailed and it’s easy to mess up. And the problem with IRAs is that if you get it wrong, the penalties can be steep.
- An introduction to Sarah and her work (3:34)
- Why IRAs are an “overlooked tool” and “a great strategy for saving for retirement” (5:05)
- The next step once you understand the type of account you have (09:40)
- Traditional versus Roth IRA (14:03)
- Clearing misconceptions around Required Minimum Distributions (21:01)
- How does a beneficiary IRA work? (25:27)
- Differences between a “transfer” and a “rollover” (31:36)
- What you need to know regarding IRAs and divorce (33:31)
- A real-life case of an IRA-related mishap (38:16)
Stephanie McCul…: 00:06 Welcome to Take Back Retirement, the show for women 50 and better facing a financial future on their own. I’m Stephanie McCullough. And along with my fellow financial planner, Kevin Gaines, we’re going to tackle the myths and mysteries of quote unquote retirement, so you can make wise decisions toward a sustainable financial future. Through conversations and interviews. You’ll get the information and motivation you need to move forward with confidence, and we’ll be sure to have some fun along the way. We’re so glad you’re here. Let’s dive in.
Kevin Gaines: Several years ago, when I was just a young advisor, wet behind the ears, I had the opportunity to go to an IRA conference, which seemed silly to me, but it was taking place in Las Vegas. So who am I to say no, to try to shake down my old boss, to pay for me, to take a little trip to Vegas? Which I did and I walked into the conference thinking, ‘well, maybe I’ll learn one or two little things.’ Well, two and a half days later, I walk out of there realizing I know nothing. Everybody thinks IRAs are really simple. You just put the money in, you take the money out. And for some of us we’re lucky enough, but most of us there’s a lot of complications.
Stephanie McCul…: Coming to you semi-live from the beautiful Westlakes Office Park in suburban Philadelphia. This is Stephanie McCullough and Kevin Gaines of Sofia Financial and American Financial Management Group. Say, ‘hello,’ Kevin.
Kevin Gaines: Hello, Kevin.
Stephanie McCul…: Today we have an awesome guest. I’m really excited. We have Sarah Brenner, Director of Retirement Education at Ed Slott and Company. And she truly is an expert in IRAs, individual retirement accounts, which for so many of us form the crux of our plan to save for retirement.
Kevin Gaines: Yeah, I’ll tell you what, I met Sarah a few years ago because Ed Slott and Company, they have part of their practice, in addition to the PBS specials that many of you might be familiar with, they spend a lot of time working with financial professionals, advisors, accountants, lawyers, and such in navigating the shockingly complex world of retirement accounts. And Sarah is my go-to person. Whenever I have a question, this is who I go to.
Stephanie McCul…: It is amazing that she started out practicing as an attorney, but now this is her full-time gig. Really digging in to the nitty-gritty of these rules because it is so complicated and it can trip people up.
Kevin Gaines: It is, I profess to be an expert or concentrate on retirement accounts. This is what I work with day in and day out. And it still comes up. And several times that, there’s just something weird or it’s so complex, you really want to get a second set of eyes or a third set of eyes on it to make sure because the problem with IRAs is if you get it wrong, the penalties can be steep. You don’t want to get this wrong.
Stephanie McCul…: So, let’s dig in and hear what Sarah has to tell us.
Stephanie McCul…: Sarah, welcome. We’re so happy you could join us today.
Sarah Brenner: Thank you for having me. I’m excited to be here.
Kevin Gaines: So, Sarah, let’s start off with who you are, who Ed Slott is and why should we listen to you?
Sarah Brenner: I’m an attorney. I did graduate from law school and I practiced for a couple of years. And then I found my true love – IRAs. [laughter]
Stephanie McCul…: [laughter]
Sarah Brenner: I started working with IRAs in the late nineties, 1997, when the Roth first became available. That’s when I jumped in with IRAs and I’ve been in that specialized area ever since. I’ve been with Ed Slott and company for five years now.
Kevin Gaines: And for those not familiar with his PBS specials, who is Ed Slott or what is Ed Slott and Company?
Sarah Brenner: Ed Slott, my boss, is probably the preeminent IRA expert in the country. He’s a CPA. He does have a tax practice, but his focus really is IRAs. At Ed Slott and company, we have a website, we have a monthly newsletter and we have a group of specially trained advisors that we call our elite advisors who are up to date on all the latest rules, regulations, court cases, anything dealing with retirement accounts, which for people that’s a big, big part of their estate, their assets.
Stephanie McCul…: That’s for sure. And that’s why Kevin is one of those elite advisors.
Kevin Gaines: [laughter] You know it.
Stephanie McCul…: 4:54 So if you had to give people kind of a big picture thought about IRAs and especially kind of what women need to know, kind of what’s the short version of the message that you would have for our audience?
Sarah Brenner: I think they are an overlooked tool. I think IRAs are a great strategy for saving for retirement. And sometimes I think we forget about them because as you’re saying, they do seem, so simple, but I agree with what you’re saying too about it being deceptive. There are rules that can be a little tricky. So with IRAs, you have the good and the bad, a great way to save for retirement. But for people who aren’t careful, there are some pitfalls.
Stephanie McCul…: Just so people kind of understand the gravity of the situation, if someone a mistake, what could go wrong? It’s not necessarily just a slap on the hand from the IRS, right?
Sarah Brenner: No, no. You can be looking at some serious tax consequences. If you make a mistake with your IRA, you could have somebody who saves for years and years and if they don’t follow the rules, they could end up with their entire IRA being considered distributed and taxable to them. And sometimes there are penalties that apply. So you do want to know the rules.
Stephanie McCul…: And so, the problem there is if the entire amount is taxable in one year, you’re pretty quickly going to potentially get into that highest tax bracket. Right?
Sarah Brenner: Yeah. Lump sum distribution is not pretty when it comes to the tax consequences,
Stephanie McCul…: As opposed to most people, the plan is to slowly take their money out over their lifetime. And then usually, those amounts don’t knock you into the highest bracket.
Sarah Brenner: That’s right. That’s right. When it’s done right, what you do is you save with your IRA for years and years, and then you want to tap it at the times that are good for you. You want to do some planning for your distributions. Now, once you reach age 72, you’re going to be forced to take distributions from your IRA. So a little bit will come out each year and you want to manage it as best you can.
Kevin Gaines: To make it even more confusing, there’s different flavors of retirement accounts. With IRAs you have four or five different things that have the letters IRA in it. You’ve got Traditionals, you’ve got Roth, you’ve got SEPs, you’ve got simples. And the rules for all of them can vary. And then if you throw in your workplace retirement stuff, 401k’s 403b’s. They have a whole ‘nother set of rules that sometimes they have similar rules in common. And other times they don’t.
Sarah Brenner: Yeah, that’s great, Kevin. Yeah. It’s a veritable alphabet soup. You’ve got several different flavors of IRAs. You have your Traditional, which has been around since the mid-seventies that gives you tax deferred growth. Sometimes you get a deduction when you contribute to it. You’ve got your Roth IRA. It’s been around since the late nineties and with the Roth, you don’t get a deduction when you put the money in, but the benefit down the road is tax-free earnings. You have SEP IRA, simple IRAs. Those are IRAs that an employer might offer. And then you have the whole world of employer plans, things like 401k’s 403b’s, 457 plans. And it’s really important that you know what type of plan you have. It sounds really basic, but there are different rules for each type of plan. So you need to know exactly what you have. It’s different to have a Roth IRA versus a Traditional IRA versus a 401k.
Stephanie McCul…: So that’s maybe the first question people should ask, right? When they’re taking stock of the various assets, they’ve got, what kind of account is this? Right? So that they can then figure out the rules.
Sarah Brenner: Absolutely. Absolutely. Not every retirement account is an IRA and there are even different kinds of IRAs. So it’s really important to look at the paperwork, talk to somebody you trust, talk to your advisor. Find out exactly what kind of plan you have, because it does matter.
Kevin Gaines: To that end, with retirement accounts, it’s better to ask the questions first. You don’t want to leap first and worry about the details later because a lot of decisions you make on retirement accounts can be irreversible. Some can be reversed, but others cannot. And some of those can be costly. So, moving from thereafter, you understand what type of account you have, what would be the next question you think people should ask when trying to figure out what they’re doing?
Sarah Brenner: 09:43 Well, I think they’re going to want to start by opening the account and funding the account. So I think you probably want to start with contributions. What types of contributions are you eligible to make? And I think this is where a lot of people give up too soon. Many people have retirement plans at work. A lot of people have 401k’s, but not everybody. Not every employer is going to offer a retirement plan. Or you might be a part-time worker who’s not eligible to participate in a retirement plan. That’s not the end of the story. You may still be able to contribute to an IRA and you don’t need your employer for that. That’s something you can do on your own, which I think is kind of empowering, especially in today’s day and age. This is something you can do for yourself. You could choose to do a Traditional IRA. You could choose to do a Roth IRA. So that’s where I would start just by knowing that there’s possibilities out there. You can think about contributing to an IRA, even if you’re not fortunate enough to have a plan at work.
Stephanie McCul…: And then one thing I think people forget about is that even if you are taking some time out of the workforce to care for family members, there’s a spousal IRA contribution, right?
Sarah Brenner: That’s true. That’s true. That’s often overlooked. And I think that is a great strategy, especially for a lot of women who maybe stay at home moms or maybe they’re taking care of elderly parents and they’ve taken a break from the workforce. They may think that there’s no way for them to see it for retirement, but that’s not true. If they’re married, they can do a spousal IRA contribution. They can put the money in either a Traditional IRA or a Roth IRA. And what you do is you use your spouse’s compensation to fund your IRA contribution. It’s your IRA and your own name, and you make the spousal contribution to it. And then, maybe you go back into the workforce, you could continue to fund that IRA with your own compensation. So it’s a great strategy that is often overlooked. And it’s important to understand you don’t have to put in the maximum contribution. I think sometimes people get a little intimidated. They think ‘$6,000, $7,000. That’s too much. I can’t do that.’ You can put in less. A little bit over time can really grow. So there’s nothing wrong with starting small.
Stephanie McCul…: That’s a good point. I like that. It’s not all or nothing. And then I think the other piece that a lot of people don’t realize is, you don’t have to do it in the calendar year. You have until your tax filing deadline. So for example, we’re recording this in late January of 2021. You can still make 2020 contributions until you file your 2020 taxes.
Sarah Brenner: Absolutely. You can make a prior year contribution for 2020. The deadline is the tax filing deadline, April 15th. So you still got a little bit of time. So you could go ahead and you can make your 2020 contribution. And while you’re at it, you can get an early start and fund your IRA for 2021, too.
Kevin Gaines: And from a budgeting perspective, not only is it not all or nothing, either, 6,000 or $0, you can do multiple contributions throughout the year or throughout actually, as we had just established over 16 months to meet that. So, $100 a month, $50, $25 a month even, or, whatever. And those little bits will add up.
Sarah Brenner: Yeah, absolutely.
Stephanie McCul…: And folks who’ve got irregular income. If you don’t have a regular paycheck coming in every month. Often what I tell them is, wait until the end of the year, see how you’re doing. If you’ve got some extra, you can put towards it, plop it in the IRA at that point.
Sarah Brenner: There’s no regular schedule that you have to be on. You can vary from year to year and maybe one year you just can’t afford to do the contribution. That’s okay. You can skip it and go back to it the next year. That’s fine.
Stephanie McCul…: Yep. So you mentioned something that I want to go back to. And I think Sarah and I discovered that we both started in the industry in the same year that the Roth IRA was born. And there’s a lot of talk about the Roth IRA, but, unless you’re kind of a personal finance geek, I think a lot of people don’t quite really get the difference. Could you just spend a minute on explaining what the Roth IRA is as opposed to your regular IRA?
Sarah Brenner: Sure. The regular IRA we call it, the Traditional IRA has been around since the early seventies. And the idea with the Traditional IRA is you make a contribution and you can deduct that contribution from your income. The contribution goes into the IRA and it’s tax deferred and any earnings that accrue in that IRA, those are also tax deferred. So no tax consequences while the money stays in the IRA. Then once you reach retirement, you take the money out. And at that point, that’s when the distributions would be taxable. But the good thing is, you’ve had years and years to accrue tax deferred earnings. Roth IRA works a little bit different. The benefits really on the back end with the Roth IRA. When you make a Roth IRA contribution, your contribution is not going to be deductible. And that of course makes a lot of people ask, well, why would I want to do it then?
Stephanie McCul…: Right.
Sarah Brenner: If I’m not getting that immediate break, right? Why would I want to go ahead and do it? Well, the benefit is on the backend. You fund the Roth IRA, your earnings in the Roth IRA grow tax-free. And because you’re funding the Roth with after-tax dollars, at the end of the day, when you take that money out, when you reach retirement, all that money, if you follow the rules, will come out tax-free. So think about it. Somebody who starts a Roth IRA when they’re 25 and they don’t touch the money until retirement age, that’s years and years of tax-free earnings. So that’s a pretty good deal.
Stephanie McCul…: 15:38 Yeah. I always say that that money, if you have some money in something with a Roth title, a hundred percent of it belongs to you, you don’t actually owe any of it to Uncle Sam.
Sarah Brenner: That’s right. That’s right. And that’s great for people who are a little bit concerned about where tax rates are going to go. You avoid any uncertainty in that area because anything you take out of your Roth IRA, again, if you follow the rules, can be tax-free.
Kevin Gaines: See, and this is the danger of an IRA conversation, because just that one answer you gave, I have like seven or eight different questions or directions that I now want to go.
Stephanie & Sar…: [laughter]
Stephanie McCul…: Just pick one. [laughter]
Kevin Gaines: Yeah. Let’s hope for the best. So Roth IRA, when you take the money out, you’re not paying taxes, but it’s also, and this is something else for people to consider, it’s not considered income from a lot of government benefits that you receive, or you’re entitled to, when you’re retired. Do you want to talk about that, Sarah? Let’s say, Roth distributions versus municipal income for social security. Again, you can quickly see how this can just go a whole different direction in this conversation, but it is important to understand when you’re planning that Roth, not just not paying the tax on those dollars, there’s other benefits to a Roth IRA.
Stephanie McCul…: So, what do you mean when you say, why should we be concerned about how much our taxable income is in retirement in regards to those other benefits?
Sarah Brenner: It works together. It’s all interrelated. Your IRA distributions are not separate from the rest of your tax situation. So if somebody is taking big distributions from their Traditional IRA, or even not so big in retirement, that can impact other things like social security. It can make your social security benefits taxable. The income from your IRA distribution is going to count when you’re looking at Medicare surcharges. I know no one likes the IRMAA surcharges. Nobody likes to pay those. Well, your IRA distributions are going to bump up your taxable income, which can mean that you’re going to have to pay more for Medicare. Those IRMAA surcharges kick in and IRMAA is a cliff, which means if you go a dollar over certain income limits, all of a sudden you have a big surcharge. So it’s really something to watch out for. All of that is not a concern with a Roth distribution.
Sarah Brenner: So, all that complexity, all that concern about how your income is going to be impacted. You don’t have any of that if you go with a Roth. And I think it’s important to mention that there’s another way that you can get a Roth IRA besides making tax year contributions, those $6,000 and $7,000 contributions that we talked about. You also could convert any existing Traditional IRA. So if you’re sitting there and you’re hearing our conversation and you’re thinking, ‘oh no, I have this rather large Traditional IRA. Is that going to be a problem for me when I retire? Is that going to impact my social security? Is that going to impact what I pay for Medicare?’ You may want to think about converting. You can convert a Traditional IRA to a Roth IRA. So for a lot of people, that’s something worth exploring. It’s a proactive step you can take.
Stephanie McCul…: When we talk to clients about it, it sounds great until you realize that the amount you convert, for example, in 2021 becomes taxable income in 2021, because nobody really wants to pay that tax, right?
Sarah Brenner: That’s no fun. Nobody wants to pay a tax that they don’t have to pay. That’s very true.
Stephanie McCul…: But it’s one of those things where having the bigger picture in mind and, kind of zooming out and looking at the whole scope of your financial implications over your lifetime can be useful.
Sarah Brenner: 19:39 Absolutely. I say it’s better to pay taxes on your IRA, on your schedule versus the government schedule. Because remember, if you hold onto the Traditional IRA, they’re going to force you to take required minimum distributions, certain set distributions need to come out each year. If you convert your Traditional IRA to a Roth IRA, you get to choose when you want to do it. You can choose the time that’s most advantageous for you. It’s another situation where it’s not all or nothing. Maybe you want to do some partial conversions and fill up lower tax brackets. You can do that. So you have a lot of options. And the way I see it, it’s like pulling off a band aid. If you do it at once and, get the pain over with, maybe you’re in a better position than if you do slowly. If you keep the Traditional IRA and have distributions dripping out slowly, over years and years, that can affect your tax situation in many, many years going forward. I like what you said about the big picture. You got to think about the big picture.
Stephanie McCul…: So, I want to go back to what you just mentioned about, ‘you have to take your money out at a certain date.’ And I think a lot of people that I’ve spoken to, they kind of had this idea like, ‘oh, I actually am not allowed to take money out until the government says I have to and then I can’t take more than that.’ There’s a lot of confusion around what we call required minimum distributions. Could you talk about that for a minute?
Sarah Brenner: Yeah, sure. Required minimum distributions. The big word here is minimum. That’s the minimum amount that you have to take out to avoid getting into trouble. And by trouble, I mean a 50% penalty. Ouch. That’s the penalty that you get if you fail to take an RMD. But your IRA is yours. You can take distributions whenever you want. It’s different than say a workplace plan, like a 401k, where there are some limitations. With an IRA, you always have access to the funds. Now there may be taxes and there may be penalties. So, you’ve got to know that before you take the money out, but you always have access. We’d like to talk about the sweet spot for IRA planning, which is the period between age 59 and a half and age 72. Before 59 and a half, if you take money out of your IRA, there is a 10% early distribution penalty that’s going to apply in those cases.
Sarah Brenner: And that’s because the government wants you to preserve your IRA for retirement, right? It’s an individual retirement account. So they want you to use that money for retirement. Once you reach age 72, then those RMDs that we talked about, those kick in. But think about it between 59 and a half and 72, you can touch your money without penalty, but you’re not required to. So you have a lot of flexibility. So if you are in that age bracket, you’re in what we call the sweet spot for planning, you can get creative with taking money out of your IRA on your own schedule, and you don’t have to worry about an early withdrawal penalty.
Stephanie McCul…: So, then another benefit of the Roth IRA is that you don’t have required distributions.
Sarah Brenner: That’s right. While you are alive, you are not required to take money out of your Roth IRA. Now, after your death, your beneficiaries will have to take money out. But during the Roth IRA owner’s lifetime, they never have to touch those funds.
Kevin Gaines: Sarah, you were talking about the sweet spot being 59 and a half up to 72. I still have to process that because the sweet spot wasn’t always up to age 72, was it? It used to be a lower age.
Sarah Brenner: That’s correct. Yeah. That’s a recent law change to keep things interesting when it comes to IRAs and they’re always changing the rules on us.
Stephanie McCul…: Aha.
Sarah Brenner: And just back in 2019, we had a big tax law pass called The Secure Act. And one of the things that the secure act did was raise the age for required minimum distributions. As Kevin mentioned, it used to be 70 and a half, which is a little confusing, six months past your 70th birthday. So this is a good change. First. It pushes off RMDs for a little bit for people. Now you don’t have to start until 72 and it gets rid of that half age confusion.
Kevin Gaines: [laughter]
Sarah Brenner: 72 is a much easier age to work with, I think, than talking about 70 and a half. Again, what’s Congress doing?
Kevin Gaines: Yeah, because the 70 and a half was always, although you always had an interesting example of how to explain it. Not that it matters anymore, but it involved, who was it? Billy Joel and Bruce Springsteen. If I remember correctly.
Stephanie McCul…: What?
Sarah Brenner: Yes, yes, yes. One was born in the first half of the year. The other one was born in the second half of the year. And yes, Billy and Bruce both reached age 70 and a half in recent years and believe it or not had to start taking RMDs from their IRAs out. It’s hard to believe that they’ve been alive that long.
All speakers: [laughter]
Sarah Brenner: It happens to all of us. Even rock stars have to deal with required minimum distributions once they reach a certain point.
Kevin Gaines: 24:53 But you did mention one thing about when you pass and your beneficiaries receive your IRA. So they now have to take it out in 10 years. Which is also a change from the secure act. I’d like to spend some time talking about Beneficiary IRAs because they’re a lot more restrictive than an IRA you own yourself.
Stephanie McCul…: And very often the women are outliving the men. And so, in a heterosexual relationship, most of our clients might be inheriting an IRA from their spouse. So this is important.
Sarah Brenner: It’s really important for beneficiaries, especially spouse beneficiaries, to know their options. And I would say that the planning has to start years earlier. Retirement accounts don’t pass through the will normally. A lot of times people think, ‘oh, I have a will. Everything’s taken care of.’ That’s really not the case when it comes to your IRA. With an IRA, you have a Beneficiary designation form where a Beneficiary is named. So the IRA passes outside the will. So it’s really important. Something we can all do right now is be sure that our Beneficiary designation forms are up to date. Have you gotten married recently? Have you had a child? Those are all the sorts of things that are going to make you want to update your Beneficiary form. As I mentioned earlier for beneficiaries, the most important thing I think is to take your time, touch nothing until all your options. As Kevin mentioned, lots of beneficiaries after the secure act, the big tax legislation that we mentioned, they’re going to be looking at a ten-year payout period for their IRA, their Traditional IRA, their Roth IRA, both are going to be subject to the 10 year rule. However, there are some exceptions, and spouse, beneficiaries are one of them. Spouse beneficiaries can still stretch distributions over life expectancy or do spousal Rollovers into their own IRA.
Stephanie McCul…: Can you talk about that a little bit more? What do you mean by stretch distributions?
Sarah Brenner: Well, if you are a spouse Beneficiary, you’re going to have the option of rolling over, doing the spousal Rollover, putting the money into your own IRA. The other option is to stretch out distributions from the inherited IRA over your life expectancy. So what happens is you use a special formula and a certain set amount, which needs to come out each year based on your life expectancy. And as I mentioned earlier, that option, which we call the stretch, you hear that term thrown around a lot, the stretch IRA, that’s all we’re talking about is payments over life expectancy. That option has gone away now under the secure act for most beneficiaries. But spouse beneficiaries can still use it, if they choose.
Stephanie McCul…: And again, that stretch idea, that’s still the minimum required, right? You could have access to more of it should you need, but if you’re looking to stretch out your tax obligation, you can stretch it out over what IRS determines as life expectancy.
Sarah Brenner: Absolutely. When we talk about stretch, that is a required minimum distribution. So the minimum amount that you have to take out to avoid penalties, but you can always take more. It’s a question we get a lot from beneficiaries. There’s minimum amounts that need to come out, but you can always take more. I mentioned the 10 year rule. You could wait until 10 years down the road, the last day of that year and take the money out, or you could a week later, clean out the IRA. You have a lot of flexibility.
Stephanie McCul…: So, on the Beneficiary thing, what if I want to leave money to my children? And I’ve got an IRA, a regular IRA, I’ve got a Roth IRA and I’ve got a regular old investment account, just a taxable account in our lingo, right? No special tax rules on it. What’s the best thing to leave to the kids from a tax perspective?
Sarah Brenner: Well, the tax consequences of inheriting a Traditional IRA versus a Roth IRA, they’re going to be very different. With a Traditional IRA, most of the time, all of the money that you inherit is going to be taxable. With a Roth IRA, another plus with the Roth IRA for beneficiaries is you are looking at completely income-tax-free distribution. So, that’s a good deal. I always say, if you have a rich uncle and he’s got a big Roth IRA and a big Traditional IRA, and he asks you, which one do you want? You want the Roth IRA.
All speakers: [laughter]
Kevin Gaines: But the other danger with Beneficiary IRAs, and this gets back to why you always say, ‘do nothing at first,’ if I’m correct, is Beneficiary IRAs are irreversible. If you make a mistake with your own IRA, you might be able to get a waiver from the IRS, but you cannot get one on Beneficiary IRAs. Is that right?
Sarah Brenner: 29:47 Yeah, this is something we hear about a lot. Non-Spouse beneficiaries can’t roll over distributions from inherited IRAs. So what is see sometimes is people don’t get good advice. They don’t get any advice. They, they act too fast. They pull the trigger too soon. They inherit an IRA. Let’s say they inherit a big Traditional IRA, a million-dollar Traditional IRA. I’ve actually heard stories like this, where somebody inherits a million-dollar Traditional IRA. They really don’t understand the rules. They’re a non-spouse beneficiary. What do they do? They take a distribution. That entire amount is going to be taxable in that one year.
Stephanie McCul…: Ouch.
Sarah Brenner: That’s a huge tax hit. Yeah. And as Kevin mentioned, there are some mistakes with IRAs that can’t be fixed. That’s why they’re so dangerous. And this is one of them. If you’re a non-spouse beneficiary and you take the money out, there is no way that you can put that money back under the tax code. Non-Spouse beneficiaries, you’re going to be stuck with a taxable distribution. There’s no relief available. You can beg and plead. You can call the IRS. It’s not going to help.
Kevin Gaines: Actually, a thought just occurred to me as we’re talking here. As to the complexity of IRAs or why it could be confusing is there’s a whole different language with IRAs. Because Sarah, as you were just saying, the word Rollover, it occurred to me that to us, you say the word transfer, Rollover distribution, those mean very specific things to us, but to the average person on the street, they kind of sound like all the same thing. Will you take a moment or two to kind of talk about the difference in those words, just to try to hopefully lessen some confusion?
Sarah Brenner: Right. It’s a very, very confusing area and a very important area because people, these days they’re moving their retirement accounts all the time. They’re going from one financial organization to another, one custodian to another. And it’s important to understand that the way that you move the money matters. With a Rollover what we have is a distribution to the individual. You’re going to get a check, most likely. You’re going to get your hands on the funds and then you put it back into another retirement account. That’s a Rollover. There’s all kinds of rules that come with Rollovers. You’ve got to get the money back within a certain time period. Once you get the money, you have 60 days to get it back into another IRA. Also, Rollovers are limited. You can only do one in a 365-day period, when you’re talking about moving money between IRAs.
Sarah Brenner: Transfers are the better way to go. So if anybody out there is thinking about moving their IRA money, what they really want to do as a trustee to trustee transfer, where the money goes directly from one IRA custodian to another. Maybe there’s a better investment opportunity at the new custodian. You want to move it by transfer. You don’t want the money coming to you. You want to going directly between custodians because there are far fewer rules. There’s just much less of an opportunity to mess things up. And when you start messing up Rollovers, you get into those mistakes that can’t be fixed sometimes, and you don’t want to go there.
Stephanie McCul…: So, I’d like to spend a minute talking about divorce because the two things that very often happen to women is, we outlive the men in our lives. And then very often, we end up divorced. In fact, I saw a statistic, 80% of men die married, and 80% of women die single. So what do we need to know in regards to IRAs, with divorce?
Sarah Brenner: I think the first thing you need to understand is that IRAs are different than other assets. They carry tax consequences that other assets may not. So when there’s a divorce and an IRA is being transferred from one spouse to another or split, you really need to be sure that it’s done correctly. The first thing you need to have before an IRA can be addressed in a divorce is a court order. That’s the only way that an IRA can be split or can be transferred between spouses. Once you have the court order, you want to make sure that you process everything properly. And that’s going to mean doing a transfer from one spouse’s IRA to another, not a distribution, but as we talked about earlier, a direct trustee to trustee transfer. That will eliminate the possibility of adverse tax consequences. If you have a distribution, there’s going to be a tax bill and somebody is not going to be happy. The other part that you can’t forget with an IRA in a divorce is the cleanup part. After the divorce, everybody’s going to want to make sure that their beneficiary designations are updated. They don’t want to leave your ex-spouse on as your IRA beneficiary after a divorce. That’s just a huge can of worms you don’t want to open.
Stephanie McCul…: 34:55 [laughter] And then some people have heard that when you get divorced, and if there’s a split of say the 401k plan, there’s an option to get some money out without penalty. Right? Can you talk about the difference between if you’re talking about an employer plan versus an IRA and the splitting?
Sarah Brenner: Yeah. We talked a little bit earlier about how different types of retirement accounts have different rules. And this is a perfect example of that. If you have a 401k plan that’s being split in a divorce, you need a special kind of court order called a ‘Quadro’ Q D R O ‘Quadro.’ That’s the lingo. A Qualified Domestic Relations Order. And the way it works, if a 401k plan is being split by a QDRO, the spouse who’s being awarded part of that plan can access those funds without the 10% penalty applying. So you can access those funds penalty-free, if you want to take a distribution. You can also roll the funds over to an IRA. So that’s something else that you might want to consider. IRAs are different. This is, again, an area where there is a difference. If there’s a divorce and the IRA is ordered to be split. If those funds are accessed, there is no exception to the 10% penalty. So you can get the money, but you’re going to pay the 10% penalty. So that is an important difference between the two types of plans, IRAs versus 401k’s.
Stephanie McCul…: And I think it’s important if a woman is looking down the road and there might be divorce in her future, and there might be a settlement going on, you want to make sure that either you’re working with a professional who really knows these rules, or you get yourself some education, because you could end up with maybe assets that are going to give you a penalty and tax if you need to access them. Maybe more taxation than your spouse, right? If he gets the Roth and you get the regular IRA, right? There’s a lot of these things that you want to take into consideration.
Sarah Brenner: Absolutely. It’s a very specialized area and a lot of divorce and family attorneys just aren’t that familiar with the IRA rules. So it’s really something you have to keep an eye on. I was just working with a client the other day, and it was a really unfortunate situation where there was a QDRO and the spouse was awarded part of the 401k. So with the QDRO, she rolled the money over to an IRA. Then she wanted to take a distribution and she was facing a 10% early distribution penalty, which she would have not had to deal with, had she taken the money right from the plan under the QDRO. And really she wasn’t getting a lot of guidance from the divorce attorney, simply because they know a lot of things, but this is a very specialized area. So you need to be very careful to make sure you’re getting good, good advice when you’re faced with a divorce.
Stephanie McCul…: Yeah. That’s a good point.
Kevin Gaines: So, as we’re coming up on the end of the episode Sarah, I’m sure a lot of people listening are saying, this is some really arcane and weird stuff. Who thinks of this stuff? Does it actually ever really happen to people? Well, Sarah does all this stuff happen to real people every day?
Sarah Brenner: Oh, absolutely. It does. We see numerous court cases, rulings coming from the IRS where average, everyday people find themselves running into mishaps and pitfalls with their retirement accounts. It happens all the time. They take distributions, not understanding the consequences. They face unexpected penalties. They try moving their retirement accounts from one place to another. They do it the wrong way. They end up with the entire thing being taxable in one year. We’ve seen cases where people have been subject to unnecessary penalties in the thousands, 10 thousands of dollars. It does happen.
Kevin Gaines: Good luck with this question. Is there one case or one ruling that you find, I don’t know if entertaining is the right word or instructive, or is there a ruling or two that you would like to share to kind of point out how convoluted this can get at times?
Sarah Brenner: 39:25 Sure, sure. One case that comes to mind is a tax court case involving a man by the name of Young Kim. And one thing you should know about Young Kim, he was an educated guy. A lot of times we think, ‘these people, how much do they know?’ But we see when we look at these court cases, all kinds of people. We see teachers, we see accountants, we see lawyers. Young Kim was an educated guy. He left his job and he rolled over his retirement account from his workplace plan. He rolled it over to an IRA and then he took a distribution from the IRA and he claimed that the 10% penalties should not apply because he was age 55. And when you’re age 55, if you separate from service, you can take a penalty-free distribution.
Sarah Brenner: What Young Kim forgot about was that rule only applies to plans. It would have work if you would have kept his money in his workplace plan, but he moved the money to an IRA. That rule, that age 55 exception, that doesn’t apply to IRAs. So when Young Kim took the distribution from his IRA, he got hit with a 10% penalty. And this to me is a perfect example of what can go wrong so easily. If he would have taken the money from the plan, no penalty, you put the money into an IRA, got hit with a penalty. And another reason I enjoy this case is because I appreciate Young Kim’s argument in the tax court. He went to court and he argued these ‘rules don’t make sense.’.
Stephanie & Kev…: [laughter]
Sarah Brenner: And the court came right back and said, ‘the tax rules do not have to be logical.’ So, it’s the perfect example of how people can get tripped up. They think the rules have to be logical, as Young Kim discovered, they are not always logical. That’s why it’s important to get good advice, to look into what you’re doing before you take action.
Kevin Gaines: Yeah, it’s like Charles Dickens wrote, ‘the law is an ass.’
All speakers: [laughter]
Kevin Gaines: So, hey, I forget which book that was in. David Copperfield’s coming to mind, but I don’t think that that’s it. Anyway. But the other thing about these rulings, Sarah, is they actually sometimes create new law or new restrictions. Everything that governs retirement accounts isn’t necessarily written by Congress. Some of this stuff is for lack of a better phrase, created by the tax court or even the Supreme court, if it reaches that far, right?
Sarah Brenner: Yes, absolutely. Absolutely true. One tax court that comes to mind for me is the Bobrow case. The Bobrow case involved a New York tax lawyer who got a little too cute with the Rollover rule. He was moving money all over the place. And essentially the tax court shot him down. And what happened in the wake of the Bobrow case is the rules became much stricter. So we all suffered because this guy tried to do a little too much with his IRAs. They made the Rollover rules much stricter. Now we can only roll over one distribution from all of our IRAs within the 365-day period. And we have Mr. Bobrow, New York Tax Lawyer, to thank for that.
All speakers: [laughter]
Stephanie McCul…: Oh man.
Kevin Gaines: Yeah. Always something isn’t it?
Stephanie McCul…: Yeah, it is fascinating. I used to actually work for the federal government and I was there about five years and I learned through hard experience not to say, ‘well, you would think dot, dot, dot,’ right? Because logic doesn’t always apply to these rules for whatever reason.
Sarah Brenner: That’s what Young Kim Said, and it didn’t work so well.
All speakers: [laughter]
Kevin Gaines: Well, Sarah, if somebody wanted to follow you or follow IRAs, how do people follow you?
Sarah Brenner: You can check out our website, Ed Slott and Company. We have a great website. It’s IRAhelp.com. Pretty easy.
Stephanie McCul…: That’s great. And you said there’s a blog there and a newsletter.
Sarah Brenner: Yes. Yes. I write a blog that appears on our website, so you can check that out.
Stephanie McCul…: Awesome. Sarah, thank you so much for sharing some of your day with us and your vast expertise. We really appreciate it.
Sarah Brenner: Oh, thank you so much for having me. It was great.
Kevin Gaines: 44:11 Yeah, Stephanie, I got to tell you. Probably the biggest thing I took from this interview is Beneficiary IRAs, how complicated they can get. The rules have just changed and they could very possibly change again. And the biggest danger with them is you can’t undo your decisions, a lot of times. So probably the best thing you can do when dealing with an inherited IRA, the first time is nothing.
Stephanie McCul…: Yeah.
Kevin Gaines: Take a breath. Like the old adage is, measure twice, cut once. Just understand what you’ve got and just don’t jump into anything.
Stephanie McCul…: Yeah. So we’re seeing lots of clients and honestly, friends, who are in a situation where someone, some loved one from their family, be it a parent, a spouse, a distant cousin, has passed away and named them as beneficiary on their retirement account. And Oh my gosh, this is money in the door. That’s awesome. This is lovely. But take a minute. The first thing I think is to understand the titling on any account that you inherit, does it say the words IRA on it? Does it say Roth on it? Right? All of these things are important to understand. And honestly, when you’re looking through your own assets, right? Look at that title and see what it says. And if you get confused, reach out to people. Don’t be afraid to ask. I say this a million times, you don’t have to know all the answers. You have to know the questions to ask and have the guts to ask them. So start asking the questions. And if you get an answer that doesn’t feel confident or it doesn’t seem right, ask again. Ask someone else, right? Like when you talk to the airlines, if you get an answer you don’t like, ask somebody else.
Kevin Gaines: Right. You get a second opinion from a doctor. Why not get a second opinion on this?
Stephanie McCul…: Absolutely. I loved hearing from Sarah. It was really great to talk to someone who just dives so deep in all the details of this stuff. And I loved her take on the fact that most women are going to inherit, right? Statistically, we live longer. So we’re going to end up with this stuff. It is important for women to be aware of these rules. So I loved having her on.
Kevin Gaines: Yes, it was great. We’ll have to find a way to get her back again.
Stephanie McCul…: I’m sure there’s more than enough to talk about. Right?
Kevin Gaines: Absolutely.
Stephanie McCul…: All right. Well, thank you so much for being with us. Talk to you next time. It’s goodbye from me.
Kevin Gaines: And it’s goodbye from her.
Stephanie McCul…: 46:33 Be sure to subscribe to the show and please share it with your friends. Show notes and more information available at TakeBackRetirement.com. Huge thanks for the original music by the one and only Raymond Loewy through New Math in New York. See you next time.
Disclaimer: Investment advice offered through Private Advisor Group, LLC, a registered investment advisor. Private Advisor Group, American Financial Management Group, and Sofia Financial are separate entities. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investments may be appropriate for you consult your financial advisor prior to investing. This information is not intended to be substitute for individualized tax advice. Please consult your tax advisor regarding your specific situation.