Littlejohn Financial

You’re Inheriting Money: Now What?

Financial Podcast by Financial Advisors

Discover the nuances of inheriting money and how different types of assets can impact you. Join us as we explore the key aspects of inheritance and gifting that you need to know.

Episode Highlights:

  • Tax planning strategies that can save your heirs a bundle in taxes, such as adding a pay on death beneficiary to a bank account to avoid probate. 
  • How to manage the complexities of inheriting retirement accounts.
  • After-tax traditional IRA contribution that can lead to a backdoor Roth IRA strategy.
  • The two main categories of Individual Retirement Accounts (IRAs)– Traditional and Roth– and the tax implications for beneficiaries.
  • Strategic tax planning for managing large retirement accounts, including timing withdrawals to reduce tax liability and the concept of “bullying your tax rate” to fall within lower tax brackets.
  • Common misconceptions about inheritance and capital gains taxes, explaining the ‘step up in basis’.
  • Potential tax implications of adding children to property titles.
  • When life insurance may be subject to taxes.

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TRANSCRIPT

 

00:00:00 So what I hear you saying is, if this is a problem you have, call Dave and Matt offline,

 

00:00:00 Yep.

 

00:00:00 Because almost nobody has this problem. 

 

00:00:00 That is correct. And it’s a really interesting tax planning strategy. It’s also the front door into the back door Roth IRA strategy. Okay? So, why are you laughing? 

 

00:00:00 That was funny. The front door to the back door. That was a little bit of a financial advisor kind of almost joke a little bit. 

 

00:00:00 Yeah. Because we’re hilarious as financial advisors. So there you go.

 

00:00:36 All right, gang, it’s that time of the week. It’s the best Tuesday I’ve had all week. And this is the True Wealth Radio Show. And we’re excited to have you here today. Let me give you the rundown. It’s not just me, your host, Dave Littlejohn in studio today. I’ve also got with me.

 

00:00:49 Matt Dickson and someone special. 

 

00:00:52 Derek Simmons, your favorite attorney. 

 

00:00:54 He is our favorite attorney joining us today. As you guys know, we have Derek on often. Usually it is to talk about a combination of Kansas and Carolina basketball.

 

00:01:05 And I think that’s a reasonable topic. We’ve only got an hour today, so I’m gonna try to be brief. 

 

00:01:10 Okay. 

 

00:01:11 Kansas was pre-season number one and then flamed out in the round of 32 this year. 

 

00:01:15 Right. 

 

00:01:15 And that was disappointing. So now they’re pre-season number one again for next year. 

 

00:01:21 Which just makes me question what pre-season number one means. 

 

00:01:24 Nothing. That and $6 will get you coffee at Starbucks. 

 

00:01:28 Very well. Yeah, I was gonna say Carolina went in as a number one seed and flamed out in, I think the round of 16. So nonetheless, they were out, and you know what? The ducks made it farther than I expected. So there you go. The Beavers were not in. So, although the ladies did real well. Right. I think they were, what? Final four. So, are close to it. Lead eight. They did great. So, anyhow, look, today we’re going to talk about all kinds of stuff. Cause that’s what we do. Some of it will be relevant to you, and some of it you wish will be relevant to you, right? Why? Because we wanna talk a little bit about what happens when you inherit stuff.

 

00:02:07 And the first task there is, pick your parents carefully. 

 

00:02:12 Yes. 

 

00:02:13 That is very helpful. 

 

00:02:14 Yes, this is sort of like Derek and I have done estate planning like seminars together before, one of my favorites. You’re gonna get this from Derek on occasion, will be things like, Hey, if you don’t want to ever have to have a will or a trust document, what’s one of the things you could do? 

 

00:02:32 Remind me. 

 

00:02:32 Just be immortal. 

 

00:02:34 That’s true. Immortality prevents the need for a will or a trust. 

 

00:02:37 The other is if you hate your family. So those are two of my favorites. If you hate your family or you’re immortal, then by all means, you could skip the planning. 

 

00:02:45 It works well. 

 

00:02:47 Or if there are just no assets. 

 

00:02:49 That actually is one of them, but that one was not so funny. The immortal wouldn’t, really caught me. I remember you said that the first time I just went, how am I supposed to follow that? So. 

 

00:03:00 Well, and you know, a lot of people feel immortal for a certain period of their life. 

 

00:03:05 Yeah. 

 

00:03:05 They’re like, yeah, there’s no risk I’m gonna die. No risk. And then they hit about 45 and their back creaks at them. And then they go, all right, there’s a possible… possibility that I could die. 

 

00:03:15 Right. And then the hill, as I say, gets steeper. 

 

00:03:17 Yes. 

 

00:03:18 So, well, today we’re gonna talk about the other side of this, right? We’ve often had times when we have had conversations about estate planning. Okay, because I like to take advantage when I’ve got Derek in studio because he’s a wealth of knowledge on this stuff. But today I want to talk about the other side of it. What happens if you’re getting stuff? Now we’ve teased about lottery winnings before. It’s, some things in common, but believe it or not, inheritance, a lot of you out there listening are either looking at how you might pass an inheritance on. But several or many people listening might get an inheritance. And so the question is, well, then what? Okay. And one of the, what’s one of the things that is similar to, between receiving an inheritance or winning the lottery. 

 

00:04:05 Free money. It’s free money. 

 

00:04:07 Yep. 

 

00:04:07 Money that’s free. 

 

00:04:09 Is that all of a sudden people will, it’s like a new resource in their life. So what do you do with it? Spend it. Right. And it can be gone in a hurry. So, but what compounds things in an inheritance environment is that there are certain things that you may inherit that you could really increase the tax bill dramatically on, but with a little bit of planning, you may save yourself a ton in taxes. I don’t think we have to spend the whole show on this, by the way, but I think it’s relevant because if you’re out there thinking, okay, so let me ask first the question of what are some things that people inherit? 

 

00:04:48 You could inherit a parent’s IRA, so a retirement account. 

 

00:04:52 That’s a hard one though. Let’s start with the easy stuff. 

 

00:04:54 I agree. What’s an easy thing to inherit? 

 

00:04:56 A bank account. 

 

00:04:57 Bank account, piece of cake. 

 

00:04:58 Yes, and you have to go through probate to get it if you have a will or no will. 

 

00:05:02 Right.

 

00:05:03 But you just, it ends up being money. 

 

00:05:05 Yeah, now what’s one very low cost thing you could do with a bank account that would help to mitigate or avoid probate? 

 

00:05:13 You could, if you knew who you wanted to leave the money to, you could add them as a pay on death payee. 

 

00:05:19 Correct, so oftentimes known as a transfer on death or a TOD. 

 

00:05:24 And that way, they don’t have any, whoever you’re leaving the money to does not have any control over it until you actually die, but then it’s theirs without going through probate. 

 

00:05:33 Derek, would you say that the probate process has changed much over the last five to 10 years? 

 

00:05:38 I don’t know that the process itself has changed much. I know that it’s gotten really more expensive. 

 

00:05:44 I’ve heard that. 

 

00:05:44 Now, I don’t handle probates myself, but I’m hearing that probate can cost eight to $10,000 for one where people aren’t fighting. 

 

00:05:53 Right, and this is in the state of Oregon, primarily what we’re talking about when we’re talking about probate. So depending on where you’re listening or watching this thing, your mileage may vary wherever you’re at. But yeah, and why is this so important? 

 

00:06:07 Well, I mean, if you’re looking at the heirs, the people who are going to inherit things, if the cost of the trust is maybe, you know, less than that $10,000 mark in a probate court. 

 

00:06:18 It might make sense to pay some to avoid probate. 

 

00:06:20 Right. 

 

00:06:21 Exactly. This is where we, yeah, we caught Matt on that one, right? Because he just dropped an Easter egg into his comment if you were paying attention, which is, you could get a trust, which is a form of pre-planning that’s designed to avoid probate, right? And it used to be that people think, oh, trusts, they’re so expensive. Why don’t I just have a will and then go into probate, but it may actually be cheaper to do a trust now with the rising cost of probate. 

 

00:06:48 Yeah, the one good thing about probate is they charge you after you’re dead. But if you’re worried–

 

00:06:56 You don’t have to pay upfront. 

 

00:06:57 You don’t have to, but if you’re worried about how much your heirs are going to inherit, then it’s gonna come out of their pocket. So then it’s come out either while you’re alive or it comes out after you’re dead. And then you kind of want the lower number at that point. 

 

00:07:11 Exactly. And of course, since this was not supposed to be the probate show. 

 

00:07:16 It wasn’t, we’re talking about inheritance. 

 

00:07:18 Right. 

 

00:07:18 So we did bank accounts. 

 

00:07:20 Bank accounts. What are some other things that you could inherit? That–

 

00:07:24 Car. Truck, a vehicle. 

 

00:07:26 Okay, vehicles. All right, so what happens if you inherit a vehicle? 

 

00:07:30 Well, there is a title. 

 

00:07:32 Or wait, that’s not what we meant. 

 

00:07:35 Yes, you have to get your name on the title. And–

 

00:07:40 That is a probate thing. 

 

00:07:42 Well, it can be, it can be. And I have not seen that the DMV in Oregon requires you to go through probate every time. Lots of times they’ll accept alternate mechanisms of proof that you’re the right person. 

 

00:07:55 So perhaps a death certificate or something similar. 

 

00:07:57 Yeah, so that’s a possibility. 

 

00:07:59 Yeah, the issue is if the chain of custody is confusing, right, you may have a vehicle, let’s say you’re married, right? You have a vehicle in one person’s name. [DMV] may be more inclined to allow the spouse that was obvious to take, title. But if it’s a next generation, now it’s more ambiguous what the chain of custody would be. 

 

00:08:21 They may wanna see a will, even if it’s not probated.

 

00:08:24 Right. And we’re not speaking for the DMV, by the way. And again, your mileage may vary, your DMV may vary. I don’t even know. So, shouldn’t. 

 

00:08:32 So that’s, vehicle. Third one might be real estate. 

 

00:08:36 Real estate, another titled asset. 

 

00:08:38 Real estate is either going to go through probate to change the title from the dead person’s name to the people who are inheriting his name, or it can use a transfer on death mechanism to pass without going through probate, but it does make it a little bit hard to sell the property for about 18 months. 

 

00:08:57 Yeah, and–

 

00:08:59 So then, but that’s what you usually do, is the kids who inherit, or whoever’s going to inherit, has a choice, I’m either gonna live in it or I’m gonna sell it, one or the other. And so what the inheritor intends to do with it makes a difference on what the owner does in the first place. 

 

00:09:15 Okay, so we’ve covered real estate, we’ve covered personal property items, right? Well, I guess that’s really more like things with title, vehicles we’ve talked about. So what about personal property? Things that don’t have title associated.

 

00:09:31 Yeah, so those are technically supposed to go through probate. 

 

00:09:35 Exactly. 

 

00:09:35 And yet, and yet they often don’t. 

 

00:09:38 Yeah, it’s one of those things that, it’s kind of hard to account for sometimes. And it’s one of the big challenges in it, especially in a contested environment, is, well, what happens when something just walks away in the process? How do you prove–

 

00:09:54 Probate.

 

00:09:54 There it went.

 

00:09:58 That can be one of those things people fight about. 

 

00:09:59 Yeah, I can remember a story of family members and they said, well, what happened to the tractor, right? That sort of disappeared from the premise. Of course, tractors have titles associated with them. So that ultimately, you know, found its way to resolution and it was awkward because you can’t just leave and say, I have no idea what happened to it. Well, that’s funny because trying to register that thing, we discovered. 

 

00:10:22 It’s in your garage. 

 

00:10:24 Right, right, so. Who knew, right? So here’s, I think Matt, you asked one of the tricky ones right out of the gate, okay? 

 

00:10:34 Yeah, and I did do a lot of talking upfront because I don’t know the answer to what happens to an IRA. 

 

00:10:39 Right, well the good news is we do, but the first question I would ask Matt is, what kind of IRA, right? I mean, first of all, how many types of IRAs are there? 

 

00:10:50 There’s so many. You have your traditional IRA, your Roth IRA, your simple IRA, your SEP IRA. There’s a lot of different types of IRAs. 

 

00:10:57 Yep, and then there’s a lot of things that walk and talk like IRAs, but they’re not actually IRAs. 

 

00:11:03 Mm-hmm. 

 

00:11:04 Okay, so there are some things that they all have in common, right? 

 

00:11:09 Right. 

 

00:11:09 And so I think it’s probably worth us talking about some of the things they all have in common and then what are some of the differences are? 

 

00:11:15 Well, the easy one is beneficiaries. 

 

00:11:17 They do all have beneficiaries, okay? Which you can be a beneficiary to a will. Of course, there’s beneficiary pathways through probate. You could be a beneficiary in a trust that should be a pathway without probate. Or you could be a beneficiary in a retirement plan. What the heck does that mean? 

 

00:11:39 As I understand it, this is money that can’t come to me all at once. Or maybe it could, but it sucks. 

 

00:11:46 Yeah. So it can, but the question is, is that the smart move? So first let’s paint the picture. There’s two big buckets of IRA money, right? 

 

00:11:57 This is an example. 

 

00:11:58 Yeah. So you have Roth IRA money or traditional tax deferred type IRA money. Now that tax deferred–

 

00:12:07 There’s two IRAs, traditional IRA.

 

00:12:09 They’re different pathways. Right. Let’s think of it simply as, there’s a third hybrid, it’s the most obnoxious one, but let’s understand Roth and traditional first, okay? A traditional IRA, and this is gonna be like most of your employee or sponsored retirement plans. 

 

00:12:26 The stuff you haven’t paid taxes on yet. 

 

00:12:28 No taxes have come out. 

 

00:12:30 Yeah, you earn the money and before it’s taxed, we pull it out, put it into an investment and it is allowed to grow tax deferred. And then in the future, you take the money out and when you take it out, you pay the taxes as income in the future. Okay. The other basket is the Roth basket, which is you earn money, you pay the taxes and then with what’s left after you’ve already paid your taxes, you invest it and then it grows tax deferred. And if you qualify, we’ve done other shows about this, right? There’s the five year rule and some really kind of weird stuff around it. But basically assuming the Roth is sort of the switches turned on and it’s acting like a real Roth with no gotchas. So after five years, most of the time. Then when you take the money out, after full retirement age, another important caveat, tax free, right? You paid all the taxes upfront, so no taxes on the back end. The other one, you don’t pay the taxes upfront, so you get taxed on the back end. And those are the two big baskets. Now, there’s a third one that throws everybody off. 

 

00:13:36 Is this a smaller basket or multicolored or what?

 

00:13:39 So yes, smaller, multicolored. It’s kind of the way annuities work. This is the scenario where you make too much money to deduct an IRA contribution. So you make an after-tax, traditional IRA contribution, and then it grows tax-deferred, and when it comes out, some of the money was taxed and some wasn’t. And you actually have to track it to tell the IRS so that you can keep track of how much tax you have to pay on that. 

 

00:14:17 So what I hear you saying is, if this is a problem you have, call Dave and Matt offline. 

 

00:14:21 Yep. 

 

00:14:22 Because almost nobody has this problem. 

 

00:14:23 That is correct. 

 

00:14:24 Okay. 

 

00:14:25 It’s a really interesting tax planning strategy. It’s also the front door into the back door Roth IRA strategy. Okay. So, what are you laughing at? 

 

00:14:35 That was funny. The front door to the back door. 

 

00:14:38 Yeah.

 

00:14:39 That was a little bit of a financial advisor kind of, almost joke a little bit. 

 

00:14:42 Yeah. ‘Cause we’re hilarious as financial advisors. So there you go. The traditional IRA is gonna be a lot like your 401(k). So it’s gonna be a lot like a 403(b) if you’re in the public sector or, even like the IAP program for PERS, any of these. You haven’t been taxed on the money yet. So somebody has it, they’re in retirement, they’re pulling it out, paying taxes as they go, and they croak, it’s a technical term. 

 

00:15:12 Right, and now Dave, you inherit this IRA. 

 

00:15:16 Right? 

 

00:15:16 Mm-hmm. 

 

00:15:17 So first of all, I’m curious how I knew them. Right.

 

00:15:21 Yeah. 

 

00:15:21 There’s, and why does that matter? Because if you’re a spouse, then you’ve got different options than if you’re not. 

 

00:15:30 Mm. 

 

00:15:31 Right? Why does this matter? Like, first of all, a lot of people may be thinking, oh yeah, do I have that rich uncle in Zimbabwe that’s finally going to come through? Or if you’re married and you lose your spouse and they had a retirement plan in their name, well, you’re going to get some options. One of them is you can leave the money in their name and carry on until, the other is you can roll the money over into your own name. There’s pros and cons based on your age, right? As to why you would do one or the other. And again, I’m not gonna go super deep on the radio on this. I’m gonna tell you, this is where if you don’t understand the nuances, find a tax advisor or financial planner that can help you with this, right? And if you don’t know one, Matt will shamelessly give you our phone number. 

 

00:16:23 Yeah, 541-375-0898. 

 

00:16:26 Or.

 

00:16:26 You can even go to our website at littlejohnfs.com.

 

00:16:30 Right. 

 

00:16:30 Because–

 

00:16:31 Everybody’s circumstances, you know, yes, you nail that. Thank you. Yeah. So, but that’s the, between spouses, you get some options because they’re, the law allows you an unlimited transfer of assets between spouses without a tax effect, which is nice, but what if it’s not your spouse. It’s a kid, you know, somebody else that you, but it’s a person, right? You give it to a charity. We don’t worry about that. Okay, that’s great. They’re gonna take the money. And if the charity doesn’t pay taxes, they’re not paying taxes on what they get. But let’s say you’ve got a kid that’s gonna inherit this. What are their options when they inherit? Under current tax rules. 

 

00:17:11 You could open something called a beneficiary IRA and then transfer those funds into the beneficiary IRA. 

 

00:17:18 That is correct. That’s one option. So let’s start with what’s probably the less than ideal option typically. 

 

00:17:28 Pull all the money out. There was $500,000 in there. You pulled it all out because you wanted to go on a spending vendor. 

 

00:17:33 Yeah, Matt, that was really gonna help my Walmart trip, man. 

 

00:17:36 I know. 

 

00:17:37 Anything else is gonna be less happy for my Walmart trip. 

 

00:17:38 Right, so why are you gonna pull a Sheeky O’Neal and go to Walmart and drop $600,000? 

 

00:17:43 So you’re gonna just, you’re gonna inherit a big chunk of money. And why do I say big? Because if you’re gonna inherit 500 bucks, it’s probably not that big a deal. 

 

00:17:50 Right. 

 

00:17:51 If you’re gonna inherit 500,000, or more even. 

 

00:17:55 Right. If you took that–

 

00:17:56 What happens if you just cash the thing out and put it in your checking account? 

 

00:17:59 Well, if you pulled that money out of a traditional IRA, that’s now $500,000 of income for the year. 

 

00:18:06 And you’re gonna hit the highest tax bracket. 

 

00:18:08 Okay, talk to me about this, because, I mean, obviously I’m leading the witness here, but I just want you guys to explain to our listeners. What do you mean? 

 

00:18:15 Okay, well, there’s a graduated tax rate. If I only make $15,000 a year, I’m not gonna pay much taxes. If I make $500,000 a year, I am gonna make a much, pay a much higher percentage of those, of that. And I think I go from like the 0% bracket to the 28% federal bracket. 

 

00:18:35 I think it’s 37 right now. 

 

00:18:36 Holy smokes. 

 

00:18:37 Yeah, it’s high. 

 

00:18:37 And then tack on another, what? Nine, 10%.

 

00:18:40 Maybe–

 

00:18:40 Four or something. 

 

00:18:41 9.8% in Oregon, I think at that level. 

 

00:18:42 Okay, yeah. 

 

00:18:43 At least, I mean, don’t quote me on this. 

 

00:18:45 Right. 

 

00:18:45 I’m just pulling off the top of my head. 

 

00:18:46 It’s a lot. You could lose almost half of it, is what we’re trying to say. 

 

00:18:48 Yep. 

 

00:18:48 Whereas if I string it, if I string it out for longer and don’t take it all at once, then its smaller bite-sized chunks that keep me below the thresholds. 

 

00:18:56 Yeah. I believe you have like 10 years to take that money out. 

 

00:19:00 Correct, this is the key here. If you were to just take all the money at once, out of, as a beneficiary, just take a check, put it in a checking account, that’s accepting all of the money at once, and the IRS says, great, then all of the taxes that have been deferred showed up at the door with this inheritance, and you just said you’re gonna pay them all to me right now. So we’re going to take all that money and apply it, the tax bracket to it right now, and it’s gonna drive your taxes way up. 

 

00:19:29 And that’s one of the interesting things about retirement accounts versus anything else you’re gonna inherit. Anything else you’re gonna inherit, you’re probably not gonna get it until after the taxes have been paid. But an IRA is gonna come with, a pre-tax IRA is gonna come with a tax obligation attached to it. 

 

00:19:49 Right. This incidentally is also true for annuities. Okay, so an annuity has that similar issue, is that the money that the tax that’s been deferred, that deferral doesn’t disappear when you die. It gets inherited by the heir. So that’s the key. Now remember annuities just like that weird hybrid, some of it was taxed and some of it wasn’t. Some money is usually after tax and some of it is pre-taxed. So it’s a mix of what you’re gonna be taxed on, because some of it you already paid, the tax was already paid, okay? So it just depends on how the accounts were structured, but the IRS looks at it pretty simply. They get you on the way in or they get you on the way out, and they only tax stuff that hasn’t been taxed already. And let’s not talk about CECorps. And– 

 

00:20:40 So in an IRA situation, if I’m going to inherit an IRA, is the general rule that I’m always gonna wanna string it out?

 

00:20:49 So not necessarily, but if it’s a big IRA, the general rule is that you’d probably wanna string it out. And you may not need to string it out for 10 years, okay?

 

00:20:59 Right.

 

00:20:59 That you have up to 10 years with which to determine when to take the distributions. This is a change by the way from years past. You used to have different circumstance, not worth discussing because that’s not the rules anymore. But today, up to 10 years to make these withdrawals. So.

 

00:21:18 Yeah, I mean, while we’re on the inheritance topic, do we want to talk about how gifting is kind of related to this whole piece? 

 

00:21:27 So we will. 

 

00:21:28 Yeah. 

 

00:21:29 But let’s, I’d like for our listeners to kind of, let’s finish up this, this is a concept, because I think this is an important one that everybody latches onto. If you’re going to inherit this thing, you ask the question, Derek, do you want to take it all at once? I think. 

 

00:21:42 Right.

 

00:21:43 And the answer is–

 

00:21:44 What?

 

00:21:45 It depends. 

 

00:21:46 The thing I said was, don’t we always wanna string it out? 

 

00:21:49 Right. 

 

00:21:50 And then you said no. 

 

00:21:51 And I said, the answer is it depends on dollar effective tax rate, right? If it’s a really big account, you probably wanna stretch it out because you don’t necessarily want to give way more away in taxes unless there’s a really good reason. Like you just have to, you know, get a hold of to purchase something else. So.

 

00:22:10 If I’m in a really high tax bracket today right now, but I know that I’m going to retire in a year or two, I might wait till I have low income earning years and then I might pull a bunch of it out. 

 

00:22:20 Yeah. You, and the idea is, your, I use this term a lot, right? You want to bully your tax rate. Okay. I’m bullying your tax rate is kind of like, yeah, you go pushing around right? Oh, you, what, did you want a piece of this? No, no. What I’m going to do is I’m going to push you into the lowest tax environment I can. So I’m going to shift it around into different years, or I’m going to try to shift it into different types of assets that will change the way it gets taxed if possible. So that’s the idea when you’re planning, when you’re trying to be tax aware, is to try to find the areas where your tax exposure is going to be lower. And if you can’t make it lower, then you spread it out so that you’re not driving it even higher, because the way progressive tax codes work, the last dollar in is the most expensive to be taxed, right? We didn’t talk about, effective tax rate initially. We talked about, highest tax rate. Okay. So once you, you know, if you have a million dollars, you’re, you’ve finished in the highest tax bracket, but you didn’t start in the highest. So your blended rate is less than your maximum rate, but for each additional dollar you take in that maximum bracket, you’re moving your blended rate higher, right? Because it’s a more expensive tax for each additional dollar that you would draw. So that’s why we tend to stretch this stuff out. 

 

00:23:39 So, big account, stretch it out, unless you can see into the future and you know that the tax rates are gonna double next year. 

 

00:23:48 Correct. Yes, if you’re clairvoyant, you should make really good decisions. 

 

00:23:52 You really, yeah, you already know the answer. We wouldn’t even have to tell you, you know the answer. 

 

00:23:56 Yes, so in fact, if you know the answer, because you can predict the future, please call us. Wait. If you really think you know the answer, maybe you shouldn’t call us.

 

00:24:12 So Roth IRAs, as a reminder, the taxes were paid before the money got put into the retirement account. And then it grows tax-free. And then when can you take the money out? 

 

00:24:24 Okay. So this is before you’re dead, right? 

 

00:24:29 Yes. So before I’m dead, when can I take it out? And then after I’m dead, when can I?

 

00:24:33 Okay, so first it has to satisfy the five year rule. Okay. And that is tricky. If you were, the only reason we really care about the five year rule is if you have a Roth 401(k) and you’re rolling money over because every time you make a rollover or every time you do a conversion of a traditional IRA to Roth, you get a new five year window on that block of money and the five year window says once I’ve existed for five years as a Roth, the later features, right? You have the now feature of tax deferral, but the later feature is tax free. It activates the tax free nature, which means once you are beyond age, currently 59 and a half is what we consider full retirement age, after age 59 and a half, if you satisfy the five year rule, the Roth IRA distributions are tax free. 

 

00:25:26 Okay. So that’s for me. 

 

00:25:28 Yep. 

 

00:25:29 If I put money in a Roth, I can take it out after 59 and a half assuming it’s been in there for five years and I’m in good shape. 

 

00:25:35 Yeah. 

 

00:25:35 All right, now what about my children? 

 

00:25:37 Okay, the cool thing is if children inherit it, the same story is you got 10 years to take it out, but tax-free to heirs. So you could potentially still defer 10 more years of growth and allow that all to compound and then, yeah, we presume it will compound, but then at the end, 10 years, take it as a lump sum distribution and it’s still tax free. 

 

00:26:07 That’s interesting. So if they take it out in year one after they inherited it and invest and reinvest it in something else, they’re gonna pay taxes on income from that. But if they leave it in there for 10 years, all the growth is tax deferred and they don’t pay it till they take it out. So it makes great sense if they don’t have a burning need for the money to leave it in there for the full 10 years. 

 

00:26:30 Absolutely. 

 

00:26:31 Interesting. 

 

00:26:31 Yep. The Roth is, we oftentimes talk behind the scenes, it’s one of the most utilitarian tools in the financial planning tool bag. The Roth IRAs are just really cool. They’re great because there’s no required distributions, unlike traditional deferred accounts. So right now at age 73, oh, you haven’t taken any money out, the IRS says it is time. You will take some out and pay taxes or you will be penalized worse than the taxes. So they’re really serious, right? Not so with the Roth IRA because there is no tax when it comes out. So they’re in no hurry, right? And it, that benefit transitions to heirs and they get that 10 year window as well. So it’s a great tool. We encourage folks to try to have a basket because it’s also great. Here’s like, something that we think so. Okay. One of the things that’s really obnoxious is getting sick and not dying. Right, it’s super expensive. And while when you start getting into Medicare years, if you’ve got the appropriate Medicare supplements and everything else, you can have a lot of the medical components managed. The idea of needing some kind of continuum of care becomes more and more common. What am I really talking about here? 

 

00:27:51 Assisted living. 

 

00:27:52 Assisted living, long-term care event, right, where you have a medically qualifying long-term care event, maybe it’s not even medically qualified, maybe you just need assisted living. And you can buy long-term care insurance, where if you have certain qualifying events, it can be, you can use that. It’s quite expensive, right? You can buy certain forms of life insurance with accelerated death benefit associated, which is a way to sort of claw death benefit into the now, if you have certain qualifying events and use that, that’s kind of exotic. I think there are some similar annuities with features that have some riders that are around distributions for certain qualifying events. But what if you had simply a chunk of Roth IRA money that was available that could be pulled out that wasn’t taxable in the event that you needed it? And if you didn’t use it, it went to your heirs and it became a flex fund for you in retirement. So you’ve designed a retirement income between social security pensions, and other retirement plans, and this basket of Roth money is your flex pool. And that to me is the real story behind these things that we miss. And I’m talking now about the person surviving rather than the person’s inheriting. But if you inherit, might suggest that that Roth is a really powerful tool, and it can also enable you to continue funding your own Roth. 

 

00:29:20 And you know that long-term care spot is one of those, we joke about immortality. 

 

00:29:26 Right. 

 

00:29:26 But even folks who are getting to be in their 60s or 70s don’t ever think about, well, actually, I do encounter some that think about it, but many people don’t think about the possibility that they lose their ability to live independently without dying. 

 

00:29:42 Yeah. And it’s, the triggering events are their own scenario too. There’s usually six activities of daily living and I don’t remember all of them. There are things that you want to be able to do, you know, dress yourself, go to the bathroom on your own, feed yourself.

 

00:29:57 Change channels to watch Kansas basketball.

 

00:29:59 Exactly. So.

 

00:30:00 Critical. 

 

00:30:01 There are a number of those and if you can’t do those, then you would, those are qualifying events, but think about like what do you do if you need help? And so there’s a lot of people that rely on family and other folks to do caregiving, but, and some people do buy long-term care insurance. It’s just become really cost prohibitive because insurance companies look at this and say, I have no idea how to price this thing because the cost of medical, is escalating so radically that we can’t really afford to stay in this business. 

 

00:30:30 So our Roth IRA is our secret plan to pay for assisted living if we need it.

 

00:30:35 It’s certainly part of the utility. I mean, when we talk to folks right now. 

 

00:30:39 It’s not, secret if you’re gonna tell people about it. 

 

00:30:40 It’s not, but the idea of, hey, part of healthy and robust planning includes contingency planning. And that means, in my opinion, the best way that you can handle potential long-term care is self-insurance. What do I mean? 

 

00:30:57 You mean having enough money that you don’t need insurance. 

 

00:30:59 Exactly. Right? Like, why do you not typically need life insurance when you retire? 

 

00:31:05 Because you don’t have any kids in the house that you gotta worry about supporting. 

 

00:31:08 Yeah. What does life insurance do?

 

00:31:12 It buys you peace of mind that everyone’s gonna be taken care of. And if everyone’s gone and out of the house, who’s left to take care of? 

 

00:31:19 Okay. 

 

00:31:20 That’s true. Usually I hear from people who buy term insurance because they want to cover a specific thing. Like if I die, I want my kid’s college to be paid for. 

 

00:31:30 Right.

 

00:31:31 I hear from other people who just buy insurance and are not thinking about it. And they keep paying and they keep paying it. And then eventually we talk about what it’s for. They don’t have anything that, what it’s for. 

 

00:31:42 Here’s my take on what life insurance is for. It does one of two jobs, okay? And then there’s a third one that is hinky, right? The first one is it replaces income that people anticipated you earning. You were supposed to earn income that was gonna be able to pay for stuff, and now you can’t. 

 

00:31:59 But you croaked, yes. 

 

00:32:01 Right, and so we need to replace the income that was gonna come in by ensuring that ability for you to earn the income. And that’s the form of life insurance if you die and disability insurance if you don’t die. So that’s the two forms of insurance there. And life insurance is when we talk about the most because it’s the most permanent typically, or it’s the most obvious, right? Disability is one we don’t often associate as frequently, but you know if somebody dies, like that income’s definitely not returning. And we’ve seen and all heard the stories of the hardship of somebody left behind without life insurance. 

 

00:32:36 I’m guessing the second one is gonna be estate taxes. 

 

00:32:39 Exactly. 

 

00:32:40 So if I die with a bunch of real estate, I don’t want my kids to have to sell it in order to pay the state of Oregon estate taxes. So that being the case, I would buy a policy that would spin off enough money to pay the taxes, and that way they can just inherit the property and not worry about the taxes. 

 

00:32:58 Right. And the third one, which we are not gonna go deep into because it’s gonna just annoy me. 

 

00:33:04 Are you sure you wanna tell them, Dave?

 

00:33:06 Yes, I’m sure.

 

00:33:07 Fine. 

 

00:33:07 Yeah, it is… there are certain scenarios when you can build up cash value in life insurance and use it as a funding mechanism for specific purchase items. 

 

00:33:21 Are you going to talk about, whole life? 

 

00:33:23 No, I’m not. I mean, that is a feature that comes with whole life or universal or even variable universal life. But there are just so many gotchas in it and it’s such a long term commitment. And there are people out there that will sell it like this is a really amazing way to become your own bank and replace banks and all that. And my suggestion is that that is a pretty complex, really long term commitment. And so while it can academically on paper work out, I rarely see scenarios where it plays out the way it’s designed. So I’m just very careful about saying, sure, that’s a great solution. I think that’s a super, super nichey solution. And for most folks out there, I struggle to think it’s appropriate for their circumstance. So anyway, so there’s the three, okay? Now, here’s the question. What is the kind of stuff that you would most like to inherit? 

 

00:34:17 Gold bullion. 

 

00:34:18 Yes, it was just pretty good. 

 

00:34:19 Or worse-

 

00:34:20 Is it because you just wanna swim in a big pool? 

 

00:34:23 I did read about Scrooge McDuck as a child and I have to be candid, it had some appeal. 

 

00:34:27 Right. 

 

00:34:28 But I also would, I think small unmarked bills would be a fine thing to inherit, just a lot of them. 

 

00:34:34 Yep.

 

00:34:35 Turns out small unmarked bills. 

 

00:34:37 I am actually going to inherit small unmarked bills.

 

00:34:39 Yes. 

 

00:34:40 Just not very many of them. 

 

00:34:41 So the interesting thing, like inheriting cash tends to be pretty good. Right. Because there’s no tax associated with it for heirs. 

 

00:34:51 Unless you want to go buy, like a $500,000 house with cash that’s unaccounted for and then every red flag, red flag. 

 

00:34:58 Right. So let’s talk about, as an heir, what are the things, so one of the things I hear a lot, common mistake, people will say, well, great, now I’m gonna inherit this thing and I’m just gonna have to pay taxes on it. Is that so? 

 

00:35:12 Well, no, it’s gonna be taxed before they inherit it. 

 

00:35:16 Right, and it depends on which tax we’re talking about. I can only think of two taxes, really. 

 

00:35:23 Estate tax. 

 

00:35:25 Estate tax, which right, that’s the–

 

00:35:26 I have tax–

 

00:35:27 Depending on the state. What’s the other tax? 

 

00:35:30 Capital gains? 

 

00:35:32 Probably not. Probably. 

 

00:35:35 You’re gonna get a step up in basis. 

 

00:35:36 Correct. Probably it would be that IRA scenario we talked about earlier in the program. 

 

00:35:40 Oh, deferred income. 

 

00:35:41 It was deferred income, and you’ll have to pay deferred income tax. Otherwise, and you just said it, what do you mean by step up in basis? 

 

00:35:50 So if I buy property for $100, and then later on I sell it for $1,000, that’s a capital gain. 

 

00:35:58 Right. 

 

00:35:58 And I get to deduct my basis from the gain, from the sale price. So now I’m paying tax on $900 of capital gain. But if I buy something for $100, leave it to my children, die and leave it to my children. And the very next day they sell it for $1,000, then my basis increases to the fair market value on the date of my death. So they pay zero taxes. 

 

00:36:23 All right. Let me- 

 

00:36:24 Did I make that over complicated? 

 

00:36:25 Nope, nope, you actually did real well. I’m just gonna substitute one word for our listeners and see if this helps make sense. You are, your capital gain tax is on your profit. 

 

00:36:37 Yes. 

 

00:36:37 Okay, so if you bought for a hundred and sold for a thousand, you had 900 of profit. And that’s new money into your ecosystem. And the government says, we’re going to tax you on your profit. And they divide the profit into one of two categories, short term or long term. Now I’m not sure exactly why they do it, but I guess an easy way for me to remember it. If you’ve owned something for less than a year, then they consider that you’re buying it and selling it again, well then that’s your job. You’re just flipping through these things and so you got your day job, so they’re going to tax it as so it looks like income. It’s not an income tax because it was in fact a profit, but they’re gonna tax it that way and they’re gonna call that a short-term capital gain because you held it for less than a year. Longer than a year, they’re gonna call it long-term capital gain and they’re going to change the tax rate on it. And it’s gonna become lower and more favorable. It’s a really important thing to remember out there, by the way. But for people inheriting, your point is the profit basically gets erased because it’s like getting a reset to the current value the day they inherit. 

 

00:37:42 That’s correct. And this is one of the things that comes up in lots of estate planning discussions is parents will say, what if I just add my children onto the title of my property? 

 

00:37:53 Right. 

 

00:37:54 But the problem is if you do that, it’s a transferred basis. 

 

00:37:58 Yep. 

 

00:37:59 So now when you die and the kids are the owners, they still only have $100 in. And if they sell it the next day for a thousand, they have $900 worth of profit. 

 

00:38:08 Yep, so you lose that sort of, I called it a racing profit. It’s, I mean, it is effectively what it is, but it’s that step up in basis. 

 

00:38:16 Right. 

 

00:38:16 Right? So typically when you inherit property, you’ll get that step up in basis, okay? And the same is true, by the way, side note for how life insurance works. Typically speaking, life insurance is going to be inherited tax free. Okay. When wouldn’t it be tax free? 

 

00:38:36 When wouldn’t life insurance be tax free? It’s going to be income tax free. 

 

00:38:40 Right. It wouldn’t be tax free in the event that it was paid for with pre-tax money. Remember the weird thing where the IRS gets you on the way in or they get you on the way out? If, in most, now health insurance is a different animal, but life insurance is what we’re talking about. If you pay for life insurance with, like, let’s say you own a business and you say, oh, I’m gonna buy insurance on myself. 

 

00:39:03 That’s the key, yeah.

 

00:39:05 And you pay for it and you write it off and then you die. The benefit now becomes taxable. 

 

00:39:11 So this is why we tell people never deduct life insurance payments in a business if you’re both the payer and the beneficiary, it doesn’t work. 

 

00:39:19 Correct. So you don’t want to have your death benefit sort of, take be, like goofed up. 

 

00:39:28 That’s a good one. 

 

00:39:29 So you pay for life insurance with after-tax money. Okay? Now, all of this, in the end of the day, if you were inheriting, there’s a couple things to keep in mind, right? One, hopefully, there’s emotions associated with this. I encourage everybody, take your time making decisions, especially if you’ve gone through a really emotionally traumatic experience, you don’t want to necessarily have your judgment clouded because of what’s going on, so. 

 

00:39:56 We need a one week waiting period before Matt goes to Walmart. 

 

00:39:59 Well, you’ll never find me in a Walmart, but most of Douglas County, you’ll find me. 

 

00:40:03 Right. And so that’s the first thing though, is just be slow and deliberate. If you are emotional, I would encourage you to find somebody else that you can kind of run ideas by. This is where a financial professional can be really valuable. And then the other, I think, is if you’re going to inherit stuff is you take the time to understand the tax ramifications before you make those decisions. There’s the emotional side and then oftentimes we don’t know what we don’t know. If you’ve heard this program, like I said, get the podcast, send it to a friend because if you’ve got heirs out there, you want to make sure that you navigate this cautiously. On the last one, look, if you’re in the planning process and you are trying to set this up so your heirs are in good shape, you can call Derek.

 

00:40:52 Absolutely. 541-677-7185. 

 

00:40:56 Okay. And if you are in the process of inheriting and you would like some help navigating, you can certainly call us. Yeah.

 

00:41:04 541-375-0898. 

 

00:41:07 Okay. Us being, you know, Matt and Dave. I will also tell you that we will offer a free consult on any of this stuff. Our goal is to just get you in the right spot. If it ends up that you’re a good fit and we become, have a customer relationship together, awesome. But if not, that is okay. The purpose here, just like this program, we wanna make sure we get you put in the right spot so that things are working for you. And so our goal is simple. If you walk in the door, we want you to leave in a better spot than you got there. And if that means you’re working with us, wonderful. If not, we hope we’re pointing you in the right direction. So that is all. But I’m looking at the clock. Guys, can you believe it? We actually blew through the time. 

 

00:41:45 Wow. 

 

00:41:45 With only one more reference for Kansas basketball. Only time for one. 

 

00:41:49 Exactly. Well, that’s the music. We got to run. So until next time, I’m Dave Littlejohn. 

 

00:41:54 Matt Dickson. 

 

00:41:54 Derek Simmons. 

 

00:41:55 And you’ve been listening to True Wealth. Thanks for tuning in on News Radio at 93.9 FM and 1240 KQEN.

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