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Inherited IRA's

Friends of Kevin Guest Blog post from Jack Wang - A common mistake with inherited IRA's

How to inherit $40,000 and throw away almost $149,000. Or a common mistake with inherited IRAs.

Years ago, I was referred to a young couple – Bill and Mary - who wanted some help with their money.  They were both 30, had good jobs, and were looking forward to their life together.  In all respects, they looked like a typical young couple.


Some months prior, the Bill’s mother had passed away and left him an IRA worth $40,000.  One of the reasons they wanted to sit down with me was to understand their options with this account.


When it comes to inherited IRAs, there are specific IRS rules that must be followed.  Simplistically, the key question is how fast you want to take the money out.  As a non-spouse beneficiary, Bill could not combine the inherited IRA with his own.

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As the young couple was starting out, they wanted to do what many couples in their position want to do – buy a house!


Before I had a chance to speak with them, they did what most people would do in this case – they took the money out and put it as a down payment on their new home.


Let’s take a look at some numbers here:


Withdraw the $40,000 – good!


Pay income taxes as well as a 10% penalty as they are both under 59 ½ - $16,120 – boo!


Net amount is just under $24,000.


As an alternative, Bill could have taken out the money slowly based on IRS life expectancy tables.  The IRS allows beneficiaries to do this – though taxes would be due, there would not be a penalty and the remaining balance would continue to grow.


Assuming a hypothetical 5% return, what would have Bill gained by his retirement age of 67?


Over the years, Bill would have taken out almost $54,000 in distributions after tax.


PLUS the inherited IRA would still have just under $78,000 left in the account.


Plus the taxes and penalties they paid by withdrawing the account - $16,000!


Total?  Almost $149,000!


(Bill and Mary threw away $125,000!)


What if we were conservative and used a hypothetical 1% return?  Well, it would still be about $57,000.  Bill would have received $23k in after tax income.  The account will still have $18k left.  And of course, the $16k Bill and Mary paid in taxes in the beginning.


This situation reminds me of an old Sprint commercial.  There were several of this type and they still make me laugh.


Bill and Mary used that money as a down payment and I’m sure their home is very nice.  They made their decision, and I certainly wouldn't judge them for doing so.


They didn't understand IRS rules regarding this situation and it cost them.  Bill was an engineer and I can’t remember what Mary did professionally.  But neither were tax or IRA experts!  This example is one way people spend money unknowingly, without thinking it is really “spending”.


Beneficiary designations and planning isn't just about picking some names.  It also is about what options you want to leave to your beneficiaries.  This was a fairly simplistic scenario, but if siblings were involved, or the other parent (Bill’s father) was still alive, things get more complicated in a hurry.


When was the last time you reviewed your beneficiaries?



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T. Jack Wang
M.E.R.J. Financial Group 
voice - 877-226-4157

fax - 877-226-4157
Email: [email protected]