IRA/401k Money Is Different

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Welcome to Finishing Well. A certified financial planner, Hans Scheil, and today's show is IRA 401k money is different. In other words, IRA 401k money is different. What do you mean by that?

Well, I think when you listen to this show, you're going to discover that there are 17 points of differences that we're going to go over. But in the end, what you're going to see is that IRA money has a lot more rules, right, and a whole lot less freedom. And I don't know if you're familiar, but there's kind of a correlation between the Old Testament, you know, the Jewish people feel like there's 613 commandments that they have to abide in order to merit, you know, the Messiah coming.

Interestingly, they never kept him. And the Messiah still came. And when he did in Galatians 5, 1, you know, he says it was from freedom's sake, it was for freedom's sake that Christ set you free. And so much of what we'll hear about in this financial planning that Hans and Tom do is setting your money free, right, through different strategies and whatever is to allow that money, the freedom to do, you know, what you need it to do in order to finish well. And so with that said, Hans, jump in.

There's a great correlation there between the Old Testament and the New Testament. There's at least 613 rules for IRAs, 401Ks, maybe more than that. And when your money's out of there, I mean, sure, you got to pay taxes, but that's about the only rule. You can invest it, you do with it what you want, spend it, save it. So there's advantages to accumulate money, it's very necessary, it's great for retirement, but this thing is loaded with rules. And I want to, first of all, just talk about three financial planning points in regards to your IRA, 401K money, is you need three plans. And if you don't have this, and you're in your 60s or 50s, you need a distribution plan. You need a plan like, how am I going to distribute this money to myself?

And you're in control of when, and you're in control of a lot with this, but you need a plan. And part of that distribution plan needs to be spacing it out so you don't have any big spikes for tax reasons. So you need a distribution plan, you need an estate plan, because the estate planning is IRAs passed by beneficiaries. So you have part of an estate plan if you have a beneficiary listed, which most people do, but you need to think about the tax implications for that beneficiary. And so you need an estate plan, and you need a tax plan. And by a tax plan is once you set up these distributions, which you're going to be forced to doing at age 73, you need a plan to pay the taxes.

How much are they going to be and where's it going to come from? So a second point is IRAs are distributed and taxed differently in life and after death. And the third point I want to make is IRAs are the black hole of estate plans.

And so we've done other shows on that. And when people inherit this big taxable account, a lot of them want to know how they can get the money. And it's real easy to get the money, you pay the taxes. And they get it all bunched up in the year after death or the year of death. And it just that's what makes them the black hole of estate plan.

So moving on is we got really like you to watch the video on this show. And it lists in the show notes list 17 attributes of IRAs that show that IRAs and 401k money is different. So let's just jump right in.

All right, let's do it. So first of all, IRAs passed by beneficiary, not through the will. So every IRA has a beneficiary on it. And the only way it's going to go through the will is if you name the estate as the beneficiary, not very smart. Number two.

Before you get to number two, you know, just note to self. If you went, I didn't know my IRA had a beneficiary. Wow, you ought to go check that, you know, like, really, who is your beneficiary on your IRA? Because I assure you, it does have one and make sure that it's current and not that x y, you know, or somebody that that you didn't want that to be.

So just saying quickly once before we went too far. Yeah. So the second one IRAs have required minimum distributions, RMDs. So when you reach a certain age, you have to take a certain amount out of that account.

And there's a bit of a complicated formula for calculating it, we can help you with that. But the whole point is, there's an end of the party of the tax deferred. And it's called required minimum distributions.

Other accounts don't have those. They have complex distribution rules in life. And after death, I mean, that the RMDs, or just the distribution rules in total, and that your beneficiaries are under different RMDs, very complex. And you really, it's good to get professional help with this.

I do have a question. So, so if you have a 401k IRA, right, or whatever you want to call you have a 401k, and you're still working, right? Do you have to make minimum distributions out of a 401k? Okay, if you're still working for the employer, that you have the 401k, so you worked at this company a lot of years, you're 73. And you're still working, you're 74, 75, 76.

No, you do not have to take minimum distributions out of the 401k while you're still working. Okay, well, I learned something. All right. Yeah. Now, you still have to take them out of your IRA, or if the 401k was from another employer, but you don't still work for that other employer, you got a new one, you got to take RMDs out of there. Okay?

Okay. Number four, the distributions can incur tax penalties. What we call the penalty-free zone is 59 and a half to 73, meaning that you can take distributions and not face a penalty. Before 59 and a half, if you take a distribution out of an IRA or 401k, besides the tax, you got to pay a 10% penalty. And if you're over 73, and you don't take a distribution, you don't meet the RMD, you have an even more severe penalty for that. So tax penalties are something that we really like to try to avoid. Fifth, highly IRAs are highly taxed upon death or withdrawal. So people just need to know that these people that don't take any distributions, they just take the minimum, money's accumulating, and then they die, there's going to be a big tax bill coming due for the beneficiaries. The next one, the IRAs and 401ks are subject to double taxation at death, estate taxes and income taxes, plus state versions of the estate tax. So don't want to get into too much detail, but you have inherent income tax. But then you also, if you fall under an estate tax, you're going to pay a state tax on income tax money that you're going to pay to the IRS. So there's a double taxation thing going on.

That's not very pretty. So the seventh area is there's no step up in basis in IRAs and 401ks. So when you have money outside of an IRA, or you own stocks, or you own a business, or you own a piece of property, and the basis is what you paid for it, and if you sell it while you're alive, you got to pay capital gains tax on the amount that it increased. But if you hold it till you die, your heirs are going to inherit that with a step up in basis. It's going to be whatever they inherited that they're not going to have to pay any taxes on a capital asset. That same tax rule does not exist within an IRA. Okay?

And you're going to need to stop me when it's time to... Darrell Bock Yeah, yeah, I will. But you know, again, that step up in basis thing is always a little bit confusing, especially if you've never listened to us before. But essentially, you know, you bought a stock, it was $10,000. And you know, if you had that outside of an IRA, you know, and at the point in time you died, it was worth a million dollars, it would not affect your, the people that inherit the money would pick up the stock at a million dollars. And so they wouldn't pay capital gains on the difference between 10,000 and a million. However, if that was inside of an IRA, they're not being a step up in basis. The people that inherited that IRA, that stock comes in with the total capital gains at 10,000, where they're going to have to, if they sell it at a million, they're going to have to pay the taxes on the capital gains, right?

Robert Hagstrom That's exactly right. And that does not exist. So you think you're getting away with something inside of the IRA, where you're not paying taxes over the years, but it's just chipping in. And it doesn't matter whether you hold it till after your death and your heirs, or you sell it or you distribute it during your lifetime. The IRS is going to get their ordinary income tax on your IRA money. Darrell Bock Right, right. So we probably got time for one more.

Robert Hagstrom Okay. So the investment gains are taxed as ordinary income, not capital gains. That's huge. I mean, ordinary income tax can be as high as 37%. Certainly up in the 30s somewhere, high 20s plus state taxes, most states don't have capital gains. And even if they did, they don't treat IRA money that way. And the capital gains, you know, we just described the step up in basis, but the capital gains tax rates are either 0% if you have a very low income, 15% or 20%. So any investment gains, you could make an argument can be held outside of an IRA. And they're more favorable tax wise.

Darrell Bock Right. And at this point might be a good time to mention that the show is brought to you by Cardinal Guide. And cardinalguide.com is again the one place that we would highly recommend you get more information on the whole subject.

So if you go to cardinalguide.com, you can click on the seven worries tabs that shown there as menu items. And one of those, of course, is IRAs. And that's what you're going to find some amazing show notes. And as Han said at the beginning of the show, this would be a great video to watch if you want to really understand these differences between IRA money and regular money.

And it goes into great detail plus has all sorts of notes along these lines of what we're talking about and of course able to go into all 17, which we don't know that we're going to be able to in the show today. But again, that's all there at cardinalguide.com as well as Hans' book, The Complete Cardinal Guide to Planning for and Living in Retirement. And of course, the Contact Hans and Tom Page, which is the easiest way to find out the difference in your case, what might be going on with your IRA money. Again, it's all at cardinalguide.com. We'll be right back with a whole lot more on 401k and IRA money.

What's the difference? Investment Advisory Services offered through Brookstone Capital Management LLC, abbreviated BCM, a registered investment advisor. BCM and Cardinal Advisors are independent of each other.

Insurance products and services are not offered through BCM but are offered and sold through individually licensed and appointed agents. Cardinal Advisors is not affiliated with or endorsed by the Social Security Administration or any other government agency. Welcome back to Finishing Well with Certified Financial Planner, Hans Seil. And today's show is IRA 401k money is different.

And we're talking about different from regular old money that you have in a savings account or CD or something like that, or even in an investment account. So we're getting into these 17 differences and carry on Hans. Okay, yeah, just a little bit of level setting. We got through eight of them. And the purpose of this show was not to teach you the eight we went over in the beginning and the, I guess, nine that we're going to go over in the second half of the show. The purpose was not to teach you these items individually, just to point them out. We have separate shows on every single one of these. So and we're certainly available that we're not going to come when you come in to see us, we're not going to apply all 17 of these to your IRA.

I just want you to know we're thinking about them. And so I'm really rattling off a lot of information and the gist of the difference between IRA money. So here's one that we're going to start on that IRA money is a little more favorable is investment gains are not subject to the 3.8% investment tax. So there's this extra tax called the net investment income tax 3.8%. And it has a pretty high threshold for it. But the IRA money and 401k money doesn't count toward that.

So good to know. Next one is that IRAs cannot be gifted or transferred during life, except in a qualified charitable distribution or divorce. So with those two exceptions, let's just talk about you can't transfer your IRA even to a trust. I mean, you just your IRA and your 401k needs to stay in your name, not your husband or wife's name, your name, and it needs to stay there for your entire lifetime. And it's under your social security number, your age for the required minimum distributions. And then if you have your spouse as the beneficiary, then your spouse can inherit your IRA and have a bunch of privileges with it that other beneficiaries don't get. But that's not a transfer during your lifetime. It needs to stay in your name.

So you just need to remember that. And those two exceptions is a QCD is so you can once you're 70 and a half, you can donate part of your IRA to a charity. You can give it to the church, and you can even get a deduction or excuse me, you don't get a deduction. You just don't have to pay tax on the distribution.

And those QCDs count as your required minimum distribution as well. And it's frequently in divorces, they are taking part of the one IRA and assigning it to the spouse, the ex-spouse. So moving on, IRAs can transfer to trusts.

You know, I already said that one before. You cannot put your IRA in a trust. And there's some attorneys that seem to forget that while they're talking about doing that. The 12th one, you cannot change ownership during lifetime. So you can't substitute somebody else or a corporation or a trust. I mean, it needs to stay in your name and your Social Security number. You name the beneficiaries. You're responsible for the required minimum distributions until you die, and then it goes to your beneficiary, and then it's got to stay in the beneficiary's name as long as they're alive. So the 13th one, it cannot be jointly owned even in community property states.

So there are several states in the country that are community property states, which, you know, it states within the state is that when you're married, in the community property state, property is owned commonly. So you own it in its entirety with your spouse, with your wife or husband. But there's an exception for IRAs. Your IRA is yours. It's not your spouse's, okay? And your spouse's IRA is theirs.

It's not yours. Now, you may pull money out of there and split it and enjoy it commonly. And it goes on the same tax return as your spouse, but you do not jointly own it.

So how does that play out practically? I mean, so I mean, only in the cases of divorces, which is one of those places you said they could actually do some kind of a change of ownership. If you're in a community property state, and there's a divorce, is that considered differently then?

No, the divorce is going to apply in every state, doesn't matter whether it's community. What this is talking about is like, you know, with your house. I mean, you own your house jointly anyhow. Most people do with their spouse, okay?

It's written in both their names, but not everybody does. Some people are on the house before they got married. And then the spouse, the spouse, they're married, but the house is still in the mistress name. And the Mrs. just lives there, okay? And in a community property state, that house would be owned by both of them, okay? There's tax implications to this.

So we could dig down into the points. And we have and shows about community property states and how the taxation is different, how splitting up is different. I just want you to know that your IRA cannot be owned jointly with your spouse.

And there's many people that are mixed up about that. I wouldn't because if your spouse dies, or you die, and your spouse is most of the time the beneficiary, well, now she owns it. She's the IRA owner after you die. And she's got a lot of options for how she titled that. But it wasn't your name, not hers.

You died. It went to her by beneficiary. Now it's in her name. If she got remarried, she can't put it partly in the remarried name. I mean, it stays in that one person's name for their entire lifetime, okay? Exactly.

Why? It's important that you have the beneficiary, right? Because just because you're married, if you've got the beneficiary as a child or somebody else, it's not going to be her property at all, right? It is not pretty.

We found some of those after death, and it's awful. And then, you know, we've had – you need to keep your beneficiary straight. And, you know, if we do nothing more for you, I'll be happy to help you out with those. Get all of them out. You know, see if they're to your wishes.

Get them changed to what your wishes are. And then I'll show you the tax implications if you were to die, how all those beneficiaries are going to end up taxed once. And the spouse sits in the best place as the beneficiary of an IRA, and they should. So beneficiaries may qualify for special tax breaks that are often missed.

And so we've done a few videos on that. And it's just the spouse gets special tax breaks, and they have a bunch of options depending on their age, the deceased age, you know, how much money they have, what their need for distribution. So I don't want to get in and redo the video, just understanding that it's best of all to be a spouse when you're inheriting an IRA. And like I said, it should be that way. And a lot of these breaks are often missed, because people just go with the stockbroker or the bank or somebody says, Oh, you're the beneficiary. Here's what you do. And this is we sit down with beneficiaries and think through all this stuff to get the IRA titled in the best possible situation for them. Okay.

Okay. The 16th one is no principal income concept. It's impossible for us to look at an IRA and say, how much did the person that owns it, how much did they contribute, like into their 401k? And how much is investment growth? Okay, how much did they put in over the years? And then how much is investment growth on that? Nobody keeps track of it, because it doesn't matter. There is no principal, and then income or growth concept in there.

Right? And then the 17th one is IRAs require and 401ks an estate plan, because you have an estate plan if you just name a beneficiary. It just may not be planned out very well. And, you know, it really matters when you're leaving things to your spouse that you do that properly. And if you're leaving things to your kids around just a lot of blended families these days where, you know, my kids are not my wife's kids, and my wife's kids are not my kids, and people trying through their estate planning to give things to their kids from their prior marriage, and things get royally messed up. And a lot of people don't really understand what is the best type of money, either IRA or not IRA, to leave to this person or these people.

I mean, that's where we come in. And that's also where life insurance comes in, is if you've made promises to your kids when you got divorced or whatever, or when your spouse died and you made promises to your kids, and then when you got remarried, you made more promises to your kids, or at least in your mind you made them that I'm going to make sure this goes to the kids, but now you have a new spouse and you have obligations to them, life insurance is the great equalizer where we'll use that to either take care of the kids or take care of the new spouse. But with an IRA, when you have an IRA, you need an estate plan.

Right. And how about the secondary beneficiaries, right? Like in my case, my IRA, my Roth or whatever, have Tammy. Is it important you list the secondary beneficiaries as well? Well, it's very important because you and Tammy could die together. And then, you know, so that all of a sudden it's time to pay out your IRA, you're deceased, but she's deceased, and then who do they pay the money to? And so you have those contingent beneficiaries, it's going to go to them. Right.

Oh, well, I hate we're out of time, but as usual, we've run out of time for show. We want to remind you that the show is brought to you by Cardinal Guide, cardinalguide.com. And if you go to cardinalguide.com, you're going to see seven worry tabs.

And what this is today's is IRA stuff. And so if you go there, you're going to see a wonderful video with a lot more detail, extensive show notes on all that we've talked about today. It's all there at cardinalguide.com, as well as Hans' book, The Complete Cardinal Guide to Planning for and Living a Retirement. And of course, the all important contact Hans or Tom Page. It's all there at cardinalguide.com. Thanks, Hans.

Thank you and God bless you. The opinions expressed by Hans Scheil and guests on this show are their own and do not reflect the opinions of this radio station. All statements and opinions expressed are based upon information considered reliable, although it should not be relied upon as such.

Any statements or opinions are subject to change without notice. Investments involve risk, and unless otherwise stated are not guaranteed. Past performance cannot be used as an indicator to determine future results. Any strategies mentioned may not be suitable for everyone. Information expressed does not take into account your specific situation or objectives and is not intended as recommendations appropriate for you. Before acting on any information mentioned, please consult with a qualified tax or investment advisor to determine if it's suitable for your specific situation.

Finishing Whale is designed to provide accurate and authoritative information with regard to the subject covered. Investment Advisory Services offered through Brookstone Capital Management LLC, abbreviated BCM, a Registered Investment Advisor. BCM and Cardinal Advisors are independent of each other.

Insurance products and services are not offered through BCM, but are offered and sold through individually licensed and appointed agents. Cardinal Advisors is not affiliated with or endorsed by the Social Security Administration or any other government agency. We hope you enjoyed Finishing Whale, brought to you by CardinalGuide.com. Visit CardinalGuide.com for free downloads of this show or previous shows on topics such as Social Security, Medicare, IRAs, long-term care, life insurance, investments and taxes, as well as Hans' best-selling book, The Complete Cardinal Guide to Planning for and Living in Retirement and The Workbook. Once again, for dozens of free resources, past shows or to get Hans' book, go to CardinalGuide.com. If you have a question, comment or suggestion for future shows, click on the Finishing Whale radio show on the website and send us a word. Once again, that's CardinalGuide.com. CardinalGuide.com. This is the Truth Network.