How to Keep MORE of Your Inheritance From the IRS (Avoid These Tax Mistakes!)

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With solid tax planning, receiving an inheritance could provide an enormous boost on your journey to financial freedom. One misstep, on the other hand, and you could be lining Uncle Sam’s pockets. Fortunately, we’ve brought on a tax professional to help you keep as much of your newfound money as possible.

There are two certainties in life: death and taxes. In this episode of the BiggerPockets Money podcast, we’re combining them. Sean Mullaney, The FI Tax Guy, returns to the show to lend his expertise on inherited investment accounts. Whether you’re the spouse, child, or sibling of a loved one who has recently passed, you’ll need a plan for managing these financial assets. Otherwise, a huge inheritance “tax bomb” could be waiting for you down the line!

Sean discusses the four “buckets” of assets you can inherit and the steps you should take in each scenario. You’ll also learn about the “step-up in basis” exemption that allows you to dodge capital gains tax on certain accounts, as well as when you might need to take required minimum distributions (RMD)—even if you’re far from retirement. Grab your pen and paper as we get into the nitty-gritty of inheriting wealth.

Mindy:
Hello, my dear listeners and welcome to the Bigger Pockets Money podcast. My name is Mindy Jensen, and with me as always is my original, not inherited co-host, Scott Trench.

Scott:
Thanks, Mindy. Great to be here with my congenial geneal co-host, Mindy Jensen. Hi Mindy. We’re here to make financial independence less scary, less just for somebody else to introduce you to every money story because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting.

Mindy:
On today’s show, we are talking to Sean Mullaney about inherited retirement funds. Sean is a financial planner and a certified public accountant licensed in California and Virginia, and he runs the tax blog, FI Tax guy, where he gives advice and insights on tax planning and personal finance.

Scott:
And listen up because in this episode Sean’s going to explain what rut retirement funds are, the different types of inheritors who may be receiving those types of funds and who they may be receiving them from, and general frameworks for handling different buckets of assets and questions you should be asking depending on who you are inheriting funds from. This can get complex quick, so this is a great one to listen to and file away for whenever you need it, God forbid we’re all going to need this at some point, or many of us will need it at some point. It’s not pleasant, but it is hopefully helpful information that will help you through whenever you have to deal with this.

Mindy:
Yes. And this is a good one to listen to on regular speed, not 2X speed because there’s a lot of really dense information in this episode. There’s a lot of talk out there about the generational wealth transfer and how Baby Boomers will leave retirement accounts to their Gen X kids and how much or how little that will help save these generations financially. What we do know for a fact is that some people, within the course of their lifetime, will receive an inherited retirement account, and this episode is a great guide for what to do when that happens. Sean Mullaney, welcome to the Bigger Pockets Money podcast. I’m so excited to talk to you today.

Sean:
Mindy, Scott, looking forward to this conversation. Thanks so much for having me.

Mindy:
We are going to nerd out because we are going to dive deep into inherited retirement accounts. Sean, can you tell us what inherited retirement funds are and a brief explanation of what each type of account is?

Sean:
So Mindy, this is becoming much more of an issue in the personal finance space, and this has a bit of a long history. So years ago, 50, 60 years ago, a lot of affluent Americans had defined benefit pension plans. So essentially what happened is you died, maybe your spouse inherited it and then they died and then the retirement account just died with you. So it wasn’t that big a consideration. Well, over time we’ve had this massive shift away from defined benefit to defined contribution, 401(k)s, IRAs, all this sort of stuff. And here’s the thing. There are going to be many Americans who are relatively lower to middle class, not even that affluent, not the Waltons, not high dollar amounts. You could die with a $300,000 IRA. That doesn’t make you at all affluent or wealthy or rich, but what if your child inherits that $300,000 traditional IRA?
Well, now they have a potential tax time bomb and you weren’t even that rich, right? So I think it’s time for us to say there’s going to be this massive wealth transfer in this country as one generation dies out, they’re probably not going to spend every last dollar in their retirement account, IRAs, 401(k)s, 403(b)s, these types of accounts. And we have to think about, “Well, okay, what do I need to be thinking about when I inherit a retirement account?” And some people will say, “Well, there’s that step-up in basis. Isn’t this the greatest thing since sliced bread?” Well, the step-up in basis happens, what happens there is you own a taxable asset or rental real estate in your own name,. Okay, you die, your heirs get it with the so-called step-up in basis, fancy way of saying for tax purposes it’s revalued so your heirs can sell it on the way home from the funeral basically no capital gains tax.
Okay, that’s great. Well, think about the average American though. In retirement, most of their wealth is not in the taxable account. Yes, there’s some of that, but so many people out there have most of their wealth in their old 401(k) that’s now an IRA. Well, those things don’t get the step-up in basis. So we love inheriting taxable accounts, we love inheriting the old house because that even gets a step-up in basis. But when we inherit a traditional retirement account, we got to be thinking about planning and how do we manage this? It’s not the end of the world to inherit a traditional retirement account, but if it’s not managed properly, you could be opening yourself up to a big tax bill.

Scott:
Can you walk us through, let’s just start with something simple, okay? Mom and dad have a 401(k) that has $300,000 in it, right? 401(k) is tax deferred and I’m inheriting that. What is the risk? What happens if I don’t do anything correctly to me from a tax perspective?

Sean:
Scott, great question. So you’re going to inherit that thing and let’s say it’s $300,000, okay? Now we could talk about how old were mom and dad when they died and you got it. But big picture, here’s the risk. You’re going to be subject to a 10-year rule. And the 10-year rule’s going to say, “Well, Scott’s got to empty that thing within 10 years.” And so Scott, you’re going to go to the brokerage platform, you’re going to be the inherited IRA, you’re the beneficiary on that thing. And you say, “You know, if I take that money out, I’m going to be taxed on it.” And Scott, you’re doing great in life. You don’t need that money today. So you say, “You know what? I’ll deal with that later,” and then next year “I’ll deal with that later.” And now we’re in year 10, and that $300,000 IRA traditional tax deferred isn’t $300,000 anymore.
It’s had routine investment performance, maybe it’s $600,000 and you got to take out that 600,000 all at the end of year 10. That’s going to be painful from a tax perspective. What you probably would’ve wanted to have done is to say, “You know what? Okay, I got to look at my next 10 years of my life. What should I do with this traditional account? I got to pay tax on it at some point.” It’s $300,000 deferred tax. Maybe there’s some year, Scott, you say, I’m going to take a sabbatical. So that might be a year to take out more. Maybe they’re going to be a handful of years where you get a big bonus at work and things are just, you’re cooking with gas, but then you have an early retirement maybe at year eight, year nine, year 10.
Maybe what you could do is not take out so much in those years with the big bonus at work, but in years 8, 9, 10, spread that out so you don’t have $600,000 hit your tax return all in one year, and some of it’s going to be taxed at the 37% rate. That’s a really bad outcome. Maybe you could tax more of it in those years. Hey, we’re only in the 22% rate this year. Take a little bit more out. So we manage that tax liability and we save ourselves maybe 15 cents on the dollar, which could be real money, especially if that grows in the 10-year window.

Scott:
Let me just go back to the 300,000 example. Let’s forget about 10 years. I received $300,000 and I want to cash it out now and begin spending the money, forget any other strategy. What is my tax consequence in that scenario?

Sean:
So Scott, you’re absolutely allowed to do that at death. So you can spend it on the way home from the funeral. Probably shouldn’t, but you can. And what happens there it’s a lump sum distribution. That $300,000 now just shows up on your tax return. Now, very technically speaking, if mom or dad, whoever you inherited from had so-called basis, that’s a whole other conversation, you’d get to recover the basis, but there isn’t that much of that basis lurking. There’s still some in the world, but let’s just say there’s no basis. So all $300,000 is just ordinary income. It’s like you went to work and just had more W-2 income that year on your tax return. There’s no payroll tax.
The other advantage of it though is there’s no 10% early withdrawal penalty. So Scott, you could be 20 years old, you take a $300,000 lump sum distribution from inherited IRA, you just take it. It’s now not in that account. Okay, $300,000 ordinary income, but you never pay the 10% early withdrawal penalty on an inherited retirement account. It is a big advantage. So in your 20s, even though you’re in your 20s and you’re taking a retirement account distribution, no early withdrawal penalty, but it is all ordinary taxable income.

Mindy:
Let’s take a quick break.

Scott:
And we’re back. Okay, so Sean, when one is inheriting wealth, there’s a couple of buckets. I can inherit taxable or after tax property like my parents’ home or their after-tax brokerage account or their savings account. There’s retirement accounts like 401(k)s, Roth IRAs, HSAs, there may be other items to consider with that. What are the broad categories of accounts or types of assets that one can inherit?

Sean:
All right, so I would look at it as four baskets, right? The first one is the taxable assets. So this is both your brokerage account and it’s the real estate held in your own name. So you die, you leave Apple stock, VTSAX, whatever’s in your brokerage account to say your kids, right? Your kids get the so-called step-up in basis. I like to joke that some of the best tax planning is both free and inevitable. You die, your kids get the so-called step-up in basis, which means all the capital gains that accumulated during your holding period, during your lifetime, those are washed away by your own death. Really good tax rule. So the kids in theory can inherit the Apple stock and sell it immediately, no capital gain. That’s fantastic from a tax perspective. So that’s a step-up in basis and it’s everything in your own name. So it’s all the taxable accounts. It’s funny that it’s called taxable accounts, but it has the best outcome of death or one of the best outcomes of death. So that’s one basket taxable accounts.

Scott:
And there’s no tax paid to inherit those things, right, until you get into millions and millions of dollars in wealth, right?

Sean:
That’s right. So there’s no income tax on an inheritance. Now there’s a handful of states with something called a state inheritance tax. That’s a whole other rabbit hole. It’s only a very small handful of states. But federally, no income tax when you inherit. Federally, there is the so-called estate tax. We can touch on that briefly. So when you die, they do mentally, there’s this accounting of all your assets and liabilities. If you’re above 13 million, I think it’s 13.61 million in the year 2024, this number goes up. It’s subject to change. It’s a very high number.
So if you’re going to be subject to this thing, odds are you already have very sophisticated lawyers, accountants, financial planners in your life already. Most folks will never be subject to these estate tax, but that’s only assessed on the estate itself, sort of the legal residue of your life. They call it an estate when you die in estate forms. And that theoretically could pay estate tax, very rare. So yes, there’s no income tax to the beneficiaries when they inherit taxable accounts, whatever it is. Now we’ll talk about inherited retirement accounts. That’s what we’re talking about. Then we absolutely can have an income tax on it.

Scott:
Great. So this episode is for everyone who plans to one day inherit less than $13.6 million. Great. Let’s keep rolling here. What are the other baskets of assets besides the taxable ones?

Sean:
So the next one is the smallest one, the health savings account, which is sort of an interesting little one. I want to quickly address it. The HSA is a great asset to leave to your spouse because you leave the HSA to your spouse, it becomes his or her HSA. Same function, same tax planning, fantastic. What if you leave it to your adult son, adult daughter, niece, nephew, adult sibling? That tends to be really bad from a tax perspective because the problem with that is it’s all taxable to them in the year of your death and it’s no longer an HSA. So it’s a really terrible asset to leave to somebody who’s not your spouse or a charity. You could leave it to a charity and they don’t care. They don’t pay income tax. So if you’re looking to leave a little piece of your estate to a charity, an HSA is actually the first place I’d look because they don’t pay tax. It’s actually very tax efficient.
So HSAs are very bad to leave to people who are not our spouse or not a charity. So that’s the second basket. Okay, what about our third basket? Tends to be a great one. Roth retirement accounts. All right. So a Roth retirement account goes tax-free to the beneficiary. So what happens there, it depends on who you inherited it from, if it’s from a spouse, in most cases you just want to move that over to your own name. But even if it’s an inherited Roth IRA, what’s going to happen is you’ll take distributions from it and we’ll talk about the timeframe later on. But those distributions are tax and penalty free. So a Roth account can be a great account to leave to your adult son, adult nephew, adult sibling, whoever it might be. So that’s the third basket, Roth, we tend to like leaving those to individuals, spouses or otherwise.

Scott:
And the Roth will grow, continue to grow tax-free for the beneficiary so it can kind of survive the generations growing tax-free basically?

Sean:
So Scott, yes but, so that’s a big but there. So for a spouse, it can last basically the rest of the spouse’s lifetime and then they can leave it to somebody else. So for the spouse, the answer to your question is generally speaking very much yes. What if it is an adult child? Well, there was a law change back in December 2019. They call it the Secure Act. And what they say is for that adult child, they’re only going to get a ten-year continuation on that. There’s no, they call them require minimum distributions. We’ll talk about that later. But basically what happens is, say Scott, you have a father and say your father is 80 years old and he passes. He leaves his Roth IRA to you. You have 10 years to empty it out.
So if you have no spending need for that money, theoretically what you ought to do is just leave it in the Roth account for 10 years and let it grow. Let it grow tax-free for those 10 years. At the end of the 10th full year, you have to empty it out. But maybe Scott, in year two or year three, you want to put a new roof on the house. Well, you could just take that money from the Roth, inherited Roth account, and great, it’s tax and penalty free and you put on a new roof on the house and there you go.

Mindy:
The inherited Roth account, can I put that into my own Roth? Can I pull it out of my parents’ Roth and put it into mine or do I have to put it in a different type of account once I inherit it?

Sean:
Really good question, Mindy. And the answer is if it’s your parents, the answer is no. And so quick vocabulary. In that example, say your dad had a Roth IRA, he just built it up during his working years or did Roth conversions, whatever it is. He’s the “owner”. And for all of human history, he’s the owner. He leaves it to you, Mindy, right? You are the so-called beneficiary. And what you’ll have to do is you’ll have to title it as an inherited IRA and it’ll say something like, “Mindy’s dad died January 31, 2040,” whatever the year is, “and for the benefit of Mindy Jensen, benefit beneficiary.” So you don’t become the owner, now yes, it’s going to be your money, but the tax rule will say you’re the “beneficiary” and you’re the beneficiary now for the rest of human history. So you’re not allowed just to put it into Mindy’s own Roth IRA.
There’s one exception to that though. You happen to be married to a gentleman named Carl Jensen, right? We hope Carl lives for a very long time. At some point, Carl is going to pass, and assuming you have not passed at that point, what you could do is he might have a Roth IRA. He will most likely, although I don’t know your personal circumstances in this regard, but odds are he’s going to name you as the 100% primary beneficiary. And by the way, from a planning perspective, he generally should because spouses are generally very much favored. If you want to name somebody who’s not your spouse as a primary beneficiary, you want to think long and hard before doing that and probably talk to a professional advisor. But let’s say, okay, he names Mindy his 100% beneficiary on his Roth IRA, great. Mindy then can take it and make it her own Roth IRA.
And she’s, in most cases, she’s going to want to do that for two reasons. One, there’s no, they call them RMDs, Required Minimum Distributions, from your own, in your own Roth IRA. So Mindy likes that, right? Mindy’s hoping to get to 120 or beyond. So she’s going to want to put it in her own Roth IRA for that. And then in most states, there’s a little issue around creditor protection. Inherited accounts, inherited IRAs, Roth IRAs tend not to get as good creditor protection in most states than your own Roth IRA. So you’re probably going to want to have that in your own name in most cases from a creditor protection perspective as well. But again, moving it into your own name only applies if you inherit it from your spouse.

Mindy:
So if I inherit a Roth IRA from my parents, then I have 10 years to withdraw the money, but the money, because it’s a Roth account, has grown tax-free, I owe no taxes on it. So I can essentially just withdraw 10% of it every year.

Sean:
You absolutely can do that. Mindy, if your only driver is tax planning, you’re going to want to wait to the end of year 10 following the death and then take it all out then because that 10% you take out every year that’s losing tax-free growth potential for 10 years, nine years, eight years, whatever. There’s one very minor exception. If you inherited, say your parents had only owned a Roth IRA for a year or two and then they die and they leave it to you, there’s technically a five-year period. If you ever took out money that was growth in that Roth IRA within the remainder of the five-year period, you would actually owe income tax on that. That’s a very rare situation. We tend to get to that five-year period very, very quickly. Most people have 20, 30 years of Roth IRA ownership built up. So very narrow exception, and you’d only invoke that if you ever withdrew the earnings.
But anyway, so yeah, generally speaking, you could take that money out at any time tax and penalty-free. From a pure tax perspective, you want to wait as long as possible. But yeah, maybe you want to put a new roof on the house or take a three-week vacation in the tropics or something, yeah, you can take the money out of the Roth IRA tax and penalty-free.

Mindy:
Let’s take a quick break.

Scott:
And we’re back. All right, this is super helpful. Just to recap a little bit of what I’ve learned so far. There are four main buckets of assets that people are likely to inherit. Taxable assets, your parent’s savings account, the house, rental properties, businesses, whatever, right after tax brokerages. The HSA, which is not a good one to inherit and is a great one to give to charity or whatever, if you’re going to be divvying up your estate because of the immediate tax hit that will incur. There’s the Roth or the accounts that grow tax-free, like the Roth IRA, which is a great one to inherit and has a 10-year window to withdraw the funds without paying any taxes on either the property or the gains. And then there’s the 401(k), which has some complicated nuance, which we’re going to get to in a second, and the other tax-deferred accounts. So there’s the four buckets. There are also a few categories of people I believe you have, that most people are likely to inherit from, and there are things to think about in each of those cases. Can you preview those buckets of people?

Sean:
Yeah. Let’s talk about that for a second. So who do we tend to inherit significant money from in our lifetime? We tend to inherit from three classes of people. First one’s our spouse. And the rules when we inherit from a spouse are very favorable and they should be, right? We shouldn’t have big taxation problems when your spouse dies. Okay, so that’s the first bucket. Second bucket is our elderly parents, and we’ve talked about that. And for example, in the Roth IRA context, the 10-year rule applies to that. There’s a third category though, and this is not going to be an insignificant category, and that’s our own adult siblings. So sometimes we inherit from our own adult siblings and let’s apply that to say a Roth IRA. There’s an interesting little rule that applies in that case. So let’s say I have a brother named Joe. I don’t, but let’s just say I did, and he’s five years older than me and he has a Roth IRA and he dies.
He names me someone in his mid-40s as the beneficiary. Okay, what do I do then? I actually don’t have the 10-year rule then. It’s a narrow exception to that 10-year rule. I need to take it out over the remainder of my lifetime using a so-called required minimum distribution. There’s an IRS table I use. I use the previous year-end balance, and I have to take money out of that Roth IRA. It’s actually not that bad of an outcome though, because over time I have to take relatively modest amounts out and they’re tax and penalty free. So when we think about the three types of people we tend to inherit from, it’s our spouse, which could be very favorable. It’s our elderly parents, which in the Roth IRA context, we have that 10-year rule, no RMDs. And then if it’s our own adult siblings and we’re at least not 10 years or more younger than them, then we have this special rule where we could take RMDs instead of the 10-year rule and that tends to be more favorable because we’ll be able to stretch it out a little longer.

Mindy:
You have mentioned a 10-year rule several times. Is this a 10-year rule of thumb or is this a carved-in-stone rule?

Sean:
So Mindy, this is a carved-in-stone rule. When we inherit from our parents, unless we’re disabled, it has to be a very rare situation, assuming we’re not disabled or meet a very rare situation, this 10-year rule is carved in stone. So what they’re trying to do is they’re trying to make sure we do not get … I inherit at age 50 and I can spread this out ’til age a hundred, and I inherited from an elderly parent and they themselves had this huge spread. They changed the law in 2019 to say, “Starting in 2020, if you inherit from your elderly parent,” generally speaking, “you got this 10-year rule you got to deal with.”
And then the question is, well, I got to manage those 10 years and it really depends on my circumstances. So maybe I inherit and I’m in a spot where I have three years left on my working journey, and then I’m going to retire in three years. Well, maybe what I do is I don’t take much if anything in those first three years and then in years four through 10 when I’m early retired, say maybe that’s a great time to be living off this because there’s no early withdrawal penalty and maybe now my income’s artificially lower. So I have to look at my personal circumstances and this money and figure out when the heck I should be withdrawing it.

Scott:
You have a framework, I believe, that simplifies this. What are the key questions that you should be asking if you inherit?

Sean:
So the first two questions are more tax rule questions, but they matter. The first one is how old was mom or dad when they died? And the reason I ask that is because that tells me if mom or dad had begun taking, they call them requirement of distributions from the traditional retirement count, if I inherit when mom or dad had not yet reached the age of taking these RMDs, then I just have a 10-year rule, and that’s my tax rule.

Scott:
Which is 74. So if they’re over seventy-four?

Sean:
Well, yeah. So right now you have to take RMDs beginning in the year you turn 73, and there’s actually an extension for that first year, which is basically year 74, right? So you have to look at how old they were had they reached, they call it, the required beginning date.

Scott:
So are your parents over the age of 73 or 74 when they pass?

Sean:
Yeah, under today’s rules. And by the way, this will change in the future. These are just today’s rules. Okay, so that’s the first question I have to ask because if they were under that, then I just have the 10-year rule. If they were over that, then it gets a little more complicated because I have the 10-year rule, and then separately, according to the IRS in 2024, I have to take RMDs. But the funny thing is the IRS originally said that for 2022 and 2023, and then revoked that. So for those years you were just on the 10-year rule, but then in 2024 allegedly, we’re now going to have to take RMDs. But that’s an area of the law that’s actually in flux because the IRS screwed some things up. There’ve been practitioners that have commented on that. That’s a whole other rabbit hole. But so that’s the first question to ask though. How old was mom or dad when they died?

Mindy:
Sean, what do you mean by RMD?

Sean:
So an RMD is a, so-called Required Minimum Distribution. And this has sort of two flavors, right? One is I go to work, Mindy goes to work, Scott goes to work, we defer money into these traditional 401(k)s. And what the IRS is saying, and Congress is saying is, “Look, we’ll give you the tax deferral today. We’re happy to do that because we want people to have retirement savings, but we don’t want the party to go on forever.” So they say, “Look, in your 70s now when you’re retired, you’ve got to start taking that money out. You’ve got these decades of tax-free growth or tax deferred growth. We’re going to require you to take a Required Minimum Distribution.” It actually is what it says it is, it’s required. It’s a minimum amount that you figure out and it’s a distribution.
Second question is, if mom or dad had to take an RMD for that year, did they take their RMD? So maybe mom or dad was 80 years old when they died and they died January 7th, okay? Odds are they didn’t take their so-called Required Minimum Distribution for that particular year. Well, the tax rules say that RMD must be taken, and if mom or dad died and they can’t take it and you’re the beneficiary, you got to take it. Now, if there are multiple beneficiaries, technically speaking, any one of them can take it or they could split it up, but that RMD has to be taken. So that’s the second question. If mom or dad was subject to RMDs, did they take their RMD for the year? So if they died in December, the odds are yes, but we don’t know that for sure. If they died in January, the odds are no. But again, we don’t know that for sure. Maybe they took it New Year’s Day for all you know. So you got to do some diligence on that. So that’s the second question to ask.
And then the third question to ask is literally, all right, “How do I avoid this time bomb at the end of year 10? What’s the planning that’s going to be appropriate for me in terms of my income flows?” And in fact, I’ve even seen in the real world, there’s some people who make their money every two years, depending on your economic situation, the business activities you’re in, you might have odd years or your money years and then even years or your low years just depending on the particular business. So maybe you take your inherited retirement account distributions in that case in the even years, and then in the odd years you take a lot less because you’re subject to a lot more tax. So you just got to look at your particular circumstances and figure it out. And the thing is, you just got to be thinking about it. I’m not here to say I have the exact path for everybody, depends on your particulars, but you got to be thinking about it. You can’t wait ’til year nine and year 10 to figure this out.

Scott:
Awesome. Sean, do you happen to know the average age of someone who receives an inheritance?

Sean:
So I don’t know the answer to that, Scott. But here’s the thing, I think a lot of the folks in the audience are going to be inheriting these in say their 50s at a time where A, they might be high income because that’s a really good time in their career, but B, they might be on the threshold of a big decision. And so they might be saying, “Well, I’ve earned so much and I’m doing well, and maybe now’s the time to pull the trigger on retirement or sabbatical or part-time work. And oh boy, I got these inherited retirement accounts in the picture.” I think that’s going to be a very common fact pattern where we’re going to see a lot of folks in their 50s inheriting these retirement accounts. And it absolutely is a time to be very intentional around your tax planning if you’ve got one of these things in your picture.

Scott:
Yeah. I just looked it up here. And the average age, you’re exactly right, is 51 for inheritance. So that’s fairly late in life for a lot of these things. And it just goes to show, there’s two takeaways here. There’s one is here’s a framework for how to react when these unfortunate parts of life happen. And there is both death and the movement of money involved for many folks, if not most, who will be listening to this podcast at some point. And then second, there’s also some thoughts that this should hopefully get people started with and thinking about how to plan their own estates for their heirs going forward. From estate planning perspective, a big part of the game here, a big takeaway for me is how do you get money out of a 401(k) or traditional IRA as much as possible before you pass and put it into regular after-tax broker assets or keep it in the Roth area, for example, as one of those takeaways. But those are kind of long-term planning of how you get that out of there if you intend to leave things to other folks.

Sean:
Yeah, Scott, let me mention another one. I’ll come back to the HSA, right? Folks in the audience tend to love HSAs. But if you leave an HSA, like we were saying earlier, to your adult kids, that’s going to be a taxable event. Very inefficient. So what you might want to be thinking about is either one, leaving it to charity or two maybe before the second to die spouse passes, you start using it affirmatively. One to pay medical expenses, pay certain Medicare premiums, just get it out of there so it’s not going to be a taxable event. But two, I have a term, I made up a technical term. This is not a curse word, it’s called PUQME, P-U-Q-M-E, Previously Unreimbursed Qualified Medical Expenses, PUQME. So what happens is people open up an HSA and they have the weekend warrior injuries, right? They have their sprained ankles, they have whatever, their doctor visits every year, then Medicare premiums and yada yada.
They have all these previously unreimbursed medical expenses. It’s not a good thing to die with a lot of those things. Why not in your 80s, tally that up on the old spreadsheet and reimburse yourself tax and penalty free from the HSA and now it just sits in your brokerage account and then Junior inherits and it’s step-up in basis taxable account versus if you never took that affirmative step of reimbursing yourself for the PUQME. Well now it’s going to go to Junior in this HSA and Junior is going to get spiked in their tax bracket and pay tax on it. It’s called-

Scott:
PUQ money, right?

Sean:
Puq money.

Scott:
PUQ money. There you go. Previously Unreimbursed Qualified Medical Expenses, PUQME, coined by Sean Mullaney. Thank you. Thank you, Sean. That’s awesome.

Mindy:
Sean, thank you so much for your time today. Where can people find you online?

Sean:
Mindy, thanks so much. You could find me at my financial planning firm, MullaneyFinancial.com. You can find me on Twitter/X @SeanMoneyandTax and my blog FITax.com.

Mindy:
Sean, thank you so much for your time today. I know this was a lot of information for our listeners to digest. I know I’m going to go back and replay it with a notepad to take copious notes.

Sean:
Thank you, Mindy. Thank you, Scott. Really enjoyed this conversation.

Mindy:
I did too.

Scott:
Thank you, Sean.

Mindy:
All right, Scott. That was Sean Mullaney and that was, it was a really dense show, but is it weird of me to say that was super fun because I really had a good time. I had a lot of questions and he just answered them all really easily. And I have a lot more diving to do though, to discover all this 10-year rule garbage. What’d you think of the show?

Scott:
I think there are only two certainties in life, death and taxes and Mindy’s enthusiasm to talk about death and taxes. So it was a great episode. I thought we had a really, a great guest here who’s super knowledgeable about it. I really liked the framework for, hey, four buckets. And I’ll say them again here just for the people in the back, right? We’ve got the after-tax assets, we’ve got the traditional retirement accounts, we’ve got the Roth IRA, we’ve got the HSA and the different treatment and just the general questions you should be asking or frameworks you should be thinking about for handling each of those asset classes.
And then I last, I kind of want to leave with a philosophical question because, Mindy, you and I have both read Daiwa Zero, and I’m sure you were thinking back to that a little bit. And the philosophy that the author has around, “Hey, most retirements or most inheritance in this country is delivered at the age of 51, average is 51 so it means half people are getting their inheritance at 51 or older. And that’s maybe past the point where you really want to receive that inheritance and it can have the most impact on your life. Maybe that impact is in your mid-20s or early 30s at those points. And when you’re thinking about building your FI life and planning your estate with your family, that may be something you want to consider.
If you’re planning to give funds to children in adult age, maybe you want to deliver those inheritances to them earlier in life than 51, because if you take care of yourself and your FI early and you have 50 years to take care of your body, you might live to be a hundred, right? And deliver an inheritance to your adult child at 70 is very different than delivering it to them at 30. So just something to think about there that I know has something that’s been noodling on my mind as a relatively new parent.

Mindy:
Carl and I have been discussing the idea of gifting our children money now and maybe just not telling them about it, putting it into an account. The gift you can gift your, you can gift anybody, someone up to $18,000. So technically, I could gift my older daughter $18,000. My husband could gift our older daughter $18,000. That’s $36,000, but she’s 16. She doesn’t really need that right now. That could be a way to start using these funds or reducing your RMDs down the road if this is something that’s going to be an issue for you, which is we need to acknowledge what a great problem that is to have. All of this is a great “problem” to have. It’s just why, we’re approaching this from the standpoint of why pay more taxes than you have to. So if you can fidget a little bit with when you take the withdrawals and even just knowing that there’s a 10-year window, you could reduce your taxable, your tax obligation to the government. And I don’t know about you, Scott, but I spend my money better than the government does, in my opinion.

Scott:
So that leaves us with two additional takeaways. One, it really pays to listen to the Bigger Pockets Money podcast. If you are one of Mindy Jensen’s children, you are losing out because you don’t realize you might be getting a gift, but your secret’s safe here as long as they don’t listen and nobody tells them. And then second, I also think that this reinforces my long-standing belief that the Roth is superior to the 401(k), despite the numerous back-and-forth arguments. Because at the end of the day, you want your money in a Roth, not a 401(k). At the end of it all, that’s where you want it. If you’re going to have a surplus, it’s better to have that surplus in a Roth than a 401(k), so in my view.

Mindy:
Yes. And if you still don’t agree with Scott, you can email him [email protected].

Scott:
At [email protected]. All right, Mindy, should we get out of here?

Mindy:
We should, Scott. That wraps up this super fascinating episode of the Bigger Pockets Money podcast. He is Scott Trench and I am Mindy Jensen saying BRB Bumblebee.

Scott:
If you enjoyed today’s episode, please give us a five-star review on Spotify or Apple. And if you’re looking for even more money content, feel free to visit our YouTube channel at YouTube.com/BiggerPocketsMoney.

Mindy:
Bigger Pockets Money was created by Mindy Jensen and Scott Trench, produced by Kaylin Bennett, editing by Exodus Media. Copywriting by Nate Weintraub. Lastly, a big thank you to the Bigger Pockets team for making this show possible.

 

 

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.

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