Transforming an Inherited IRA into Tax-Free Retirement Wealth (107)

We unpack a strategy to transform an inherited IRA into tax-free retirement wealth through a strategic Roth conversion. A client recently inherited $52,000 from his mother and was taking RMDs without a clear plan until we implemented this approach.

What you'll learn:
• Inherited IRAs become "beneficiary IRAs" when passed down to non-spouses
• Beneficiary IRAs must be fully depleted within 10 years
• RMDs are calculated based on prior year account value and IRS tables
• Taking RMDs without a strategy can miss major tax planning opportunities

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Thanks for Listening!

Jonathan

Chapters

• 0:09 Inheriting a $52,000 IRA
• 0:25 Understanding Beneficiary IRAs
• 1:22 James' Distribution Problem
• 2:15 The Roth Conversion Strategy
• 4:24 Long-Term Tax-Free Growth Benefits
• 5:29 Episode Wrap and Disclaimer

Transcript

Speaker 1: 0:09

James inherited a $52,000 IRA at 47 years old. Here's how we made that a tax-free retirement account. Welcome back to the what the Wealth Retirement Podcast. I'm your host, jonathan Bednar, certified Financial Planner and owner of Paradigm Wealth Partners here in Knoxville, tennessee. First, let's talk about what an IRA is and what, more specifically, a beneficiary IRA is. So in this case, james inherited some money from his mom. This was an IRA and so the money had never been taxed. When someone inherits money in the form of an IRA, it becomes a beneficiary IRA. So in this case, since it was the son, we could not continue it on as his own, and since his mom was taking distributions in the form of RMDs required minimum distributions, which are required by the IRS and the government to start generating some of that tax revenue, we had to continue making those distributions, or you will have to continue to make those distributions. So it's important to understand what a beneficiary IRA is Now. Rmds are based on prior year account value and then there's a factor table that we get from the IRS website and that tells us we do a little math and that tells us how much we need to withdraw. What James didn't realize is that the money had to be depleted out of this beneficiary IRA at the end of 10 years. So he was taking the minimum, which was around $1,000 a year, out for the first couple of years 1,000, 1,200, 900. And there was really no strategy. He didn't need the money, he didn't have a plan for the money, it was just I've got to take it and so I took it. And so what's important about kind of thinking through some of these strategies is how can we actually make this money continue to work for you? So in this case again, that beneficiary IRA had to be fully depleted by the end of the 10th year and we're in year three, so we've got about seven years left to go to fully deplete this money.

Speaker 1: 2:28

And so when I started working with James, my recommendations to James was let's see if we can start making Roth contributions. He's not contributing to a Roth account now. He is contributing to a workplace plan, a 401k at his work, but he's not making any additional contributions to an IRA or Roth IRA. And so the first thing I wanted to look at was the phase out threshold. So if you make more than $236,000 in 2025, you begin to get phased out of making contributions directly to a Roth IRA. There are potentially some other ways that you can get into this. We're not talking about those today. Fortunately for James, his income was below $236,000. So we can directly make contributions into a Roth IRA for him.

Speaker 1: 3:23

So what I presented to James was if the max IRA contribution or Roth IRA contribution for 2025 is $7,000, instead of taking 1,000 or 1,200, the minimum RMD why don't we take $7,000 out? We move that into your bank account and then, once that's moved into your bank account because that now qualifies as the distribution and then we immediately take that money and we make a contribution into your Roth IRA and so after a couple of years, we will have fully depleted the beneficiary IRA that he inherited which is taxable along the way and we would have repositioned that money to grow for the next 15 or 20 years in a tax free bucket, growing at most likely multiples of what the value is today. Obviously, those aren't guaranteed and the market fluctuates, but if history is our guide, the market tends to go up, and using the Roth IRA gives that money the ability to grow tax-free, which means when he takes distributions in retirement or his family inherits that money, it comes out tax-free. So the importance of this is just having a strategy, having a plan and having someone else kind of look at these finances to see you know what are a few small tweaks I could make to really improve this investment portfolio in my long-term financial plan. So that's what we did for James Implemented a strategy to take money from a beneficiary IRA, make a distribution meaningful distribution, not just the RMD have that money depleted over that 10-year period and let that money start growing tax-free in a Roth IRA.

Speaker 1: 5:21

Be confident in your retirement. Have a wonderful day. Thanks for joining me on another episode of what the Wealth. If you enjoyed the episode today, smash that subscribe button. It helps me more than you think. Also, if you found this episode insightful and a light bulb went off, share it your friend, aunt Judy, the random guy in the office who's always talking about investments. Wealth isn't about just that should change. It's about our choices, chances and changing our financial futures. The information in this podcast is informational in general in nature and does not take into consideration the listener's personal circumstances. This podcast is not intended to be a substitute for specific and financial legal or tax advice. You should consult the approved qualified professional prior to making a final decision. Securities offered through LPL Financial member FINRA SIPC. Paradigm Wealth Partners is the other business name for Independent Advisor Alliance Investment advice offered through Independent Advisor Alliance, a registered investment advisor. Independent Advisor Alliance and Paradigm Wealth Partners are separate entities from LPL Financial.