Patti Brennan: How to Avoid Costly Mistakes With Inherited IRAs
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Welcome to Barron's The Way Forward. I'm Greg Bartalus, and my special guest is Patty Brennan, CEO of Key Financial, which she founded in 1990 and has since grown into a firm with more than $2.5 billion in assets.

Patty is also a Barron's Hall of Fame advisor and ranked high in multiple Barron's lists. Today, Patty will discuss new distribution rules for inherited IRAs and how advisors and clients can navigate what can certainly be a vexing process. Welcome to the podcast, Patty. Thank you so much, Greg. What an honor it is to be on your show.

Well, it's an honor to have you. So thank you so much. I want to first ask you about your background because you've had a great first chapter in your career. Talk about that.

So what in the world is an ICU nurse doing being the CEO of a $2.5 billion firm? I have to tell you, Greg, it's not like I intended to grow this thing to what it is. It has evolved. It has become this over time. And I can't begin to tell you how often I use the skills that I learned at the bedside in this role, not only with our clients but with my team.

And I think that's really, really important. Taking a holistic approach, recognizing that people are not their organs, their heart, their lungs, their kidneys. They are people. People aren't their money. They are their families. What do they think about at night? What do they worry about? What are their aspirations? Their taxes, their cash flow. Those are the organs that we deal with.

Who are they? What's important to them? That's what matters. And you just recently had a book published. Tell me about that. Yeah, this was kind of, it was one of those things, again, I have an advisory board and someone on the advisory board, one of my clients said, you know, Patty, when we are in your conference room, the way you explain things, you just make it so easy to understand. But then we leave and we forget about what you said.

It would be great if we could have something that we could look back, look at almost as a reference that is kind of finance 101. No jargon, none of that stuff. Just give it to us straight and give us the process and the ideas and the whys. And the title? The title of the book is, Am I Going to Be Okay? And the subtitle is, And Is Okay Enough?

What does okay mean to you? Because it is different for everyone. Yeah. And is this the intended audience, just kind of general population? You know, that question, everybody asks me that question. Who's your audience, Patty? Who's your audience? I have to tell you, I didn't want to pick my audience. I want them to pick themselves.

So there is something there for everyone, whether someone's just starting out. I use a lot of the work that Joe Coughlin up at MIT, he's the director of the MIT Age Lab. I use a lot of his work in terms of the different questions to ask, depending on the age group that we're talking with. And people with extremely high net worth, you know, high net worth clients who are looking at legacy as being their primary objective and concerns.

What I really like the title, specifically the Am I Going to Be Okay part, because...

It's not saying, am I going to be fabulously wealthy? It's lowering the bar, if you will, but it's really about crossing a threshold. And that can be a dramatically different thing depending on the person. So if someone, 2 million might be more than enough, someone would be like, I'm not sure I can get behind 2 million. So there's so many variables. And it does change over their lifetime, right? So, you know, standards of livings grow, et cetera, expectations increase, et cetera.

You know, the kids need help, et cetera. The things that we want to do for our charities, you know, come up. So it's, it does evolve. So am I going to be okay is an ongoing conversation. Yeah.

Now, linking this to the subject at hand, talking about new distribution rules with inherited IRAs, this is something that might on the surface seem slightly dry, but can be monumentally important. And if it's not handled well, well, you may not be okay. Oh, absolutely, Greg. And I got to tell you, we're going to make it fun today. Let's make it fun, and we're going to simplify a very complicated set of rules. Excellent. Okay. So-

Let's first start out. We all know about Secure Act 1.0.

You know, it was effective January of 2020, then 2.0 came out 2022. But there was this underlying question that we advisors didn't know the answer to. And that is, okay, so you have this beneficiary, they've inherited this retirement account. They have to have it drained by year 10 after the owner's death. Do they have to take distributions in years one through nine?

That question remained unanswered until July of 2024. So here are the rules. Let's break it down. Keep it simple. You've got EDs and NEDs. EDs are Eligible Designated Beneficiaries, EDs.

Those people would include the spouse, minor children, chronically ill and disabled people, or any beneficiary who was not more than 10 years younger. So it would be like a sibling.

So those are your eds. They can continue to do the stretch provision, the 10-year rule, or if we've got a cougar, for example, who inherited this retirement plan and their spouse was 15 years younger, they could take over the decedent's age. So if somebody's 75 and they were married to somebody that was 60, they all of a sudden become 60 as it relates to this rule. Those are the eds.

Very flexible. Then you have the NEDs, non-eligible beneficiaries. These are non-spouses who are more than 10 years younger, typically the kids. Here's the thing.

You know, it sounds like an infomercial, right? Wait, there's more. So within the NEDs, okay, you've got these kids. There are rules as it relates to if the owner died before their RBD, their required beginning date, their RMDH, right? Or after. If they...

If they inherited before the RBD, then they've got the 10-year drain rule, meaning they don't have to take distributions one through nine. They can just take it all out. As long as they take it out before the end of the 10th year, they're good.

for the children, for example, the kids who inherit after the RBD, then they have to take it years one through nine, plus they have to have it drained by the end of the year 10. So they're really the ones that we have to be very conscious of. Now, I've got good news as relates to this, because you mentioned at the beginning, it's really important. There's significant liability risk if we don't understand the rules.

We all have a mulligan. For example, I, Patty Brennan, thought, oh, great, I've got a 60-year-old or a 55-year-old beneficiary. He wants to retire when he's 60. He just received this significant retirement plan. We're not going to take anything in years one through five, and that'll be their retirement income the next five years. Okay? Good news is we have a mulligan.

that person, that beneficiary is not subject to the penalty because they didn't take the distributions when they should have and they also don't have to make them up. January 1st, 2025, you gotta start taking those distributions and it has to be out

by that year 10 of when the owner passed away. Otherwise there will be penalties, correct? Bingo. You got it. So tell us about the penalties or the scenarios for that. The penalties would be 25% of the amount that should have been taken out plus taxes. Wow. That's a lot. It is, you know, as Steve Lineberg once said, it's capital punishment by confiscation. I mean, they're basically taking, you know, in many cases, half of the distribution. So it's not a fun outcome and it's,

It's really simple. You just have to understand. Eds, Neds, before, after, those are the categories. Just keep them in mind. Okay. That's definitely helpful. A good way to break it down. Yeah. There's some quirky stuff in this new piece of legislation that I think any advisor needs to know about. Number one, minors. Okay. Minors are Eds. They don't have their eligible designated beneficiaries.

And by that, I mean, according to this new rule, a minor includes anyone up to the age of 21, not 18, as it is in most states. The quirky aspect of this is that they can take their RMDs based on their life expectancy.

Until age 21, then they have to flip to the 10-year rule. Okay? Don't miss that. Very important. The other quirky aspect of this rule has to do with disabled and chronically ill individuals, beneficiaries. So if the money is in a qualified plan, like honestly, like these poor people, these beneficiaries haven't been through enough.

With our medical system jumping through hoops, the hoops that they have to jump through to prove that they are disabled or chronically ill are kind of ridiculous.

if the money is still in a qualified plan. Now, I understand we've got, you know, know your client roles and best interest legislation, et cetera, but it warrants the question, how are they doing? Anything we should know about as it relates to your beneficiaries? Because in that case, if that owner rolled it over into an IRA, no obligations to report anything. If someone is disabled or chronically ill,

They don't have to prove anything to the underlying custodian. Quick question. When you say chronically ill, would that constitute someone simply having a chronic illness or being in a present state that would be, you know, they're effectively in a chronically ill condition? It's a great question, Greg. I would say it would be the latter. Someone who is presently chronically ill. Right. Getting chemo, things of that nature. Sure, sure. You know, that's

I mean, we could bend the law and hope that somebody doesn't get audited and penalized, et cetera, but I think that that would be safe. Right. Okay. Good question.

There's a third thing, and that has to do with successor beneficiaries. What's a successor beneficiary? This was a big question, and we didn't know the answer. So here's a case study, right? Grandma finally dies. She's 90 years old. She passes away. She's got this retirement plan. She leaves it to her son, Peter, who's 70. He doesn't have her genes, and he dies pretty soon after.

He leaves it to his daughter, Pam. Pam is what was referred to as a successor beneficiary. What does she have to follow? Here's the deal. If Peter was doing the stretch provision, if he was an ed and doing the stretch, then Pam has to do the 10-year role. If Peter was subject to the 10-year role, Pam has to finish the term. Okay? Okay.

So successor beneficiary, we finally have clarification. Okay. So that's basically it. You've just got to understand, you know, for all of your advisors who are listening today, understand whether your beneficiaries are an Ed or an Ned.

And then within the NED, before or after, RBD. Real simple. Don't overcomplicate it. And there's some really cool, actionable things that you can do in, you know, some cases that we've... Stop. There are some actionable...

things that we advisors can do where you become the hero, you become Superman, or maybe it's better to say Spider-Man because this is a web of legislation. So you've got Spider-Man and Wonder Woman. Be that superhero for your client.

For example, I had a client, a prospect, I should say. She was a young widow, 50 years old, came in because she was paying so much in taxes and she wanted us to do some tax planning for her. So I started to ask some questions, et cetera, et cetera. And I looked at one of her statements and her statement was it was an inherited IRA that she received from her husband.

So pretend her name was Sandy. I said, Sandy, tell me more about this inherited IRA. Well, of course, she had her 1-800 advisor who, when her husband passed away...

took his retirement plan and put it in this inherited IRA. And she's been taking distributions since he died. Well, here's the thing. She's working, making great money. She got his life insurance proceeds. She doesn't need the cash flow and she's paying taxes way ahead of time, completely unnecessarily.

So the legislation passed this year provided a fix. I said, Sandy, here's the deal. There's this new hypothetical RMD rule. Here's what you can do. Take that inherited IRA, roll it into a spousal IRA, which is what, you know, do the spousal rollover, which you are eligible for.

And all you need to do is retroactively take the minimum distributions that you should have taken had it been done correctly in the first place. Well, guess what? She's 50 years old. She didn't need to take any.

Home run. Okay. She's got a hero. Yeah. Okay. So that's, that's an idea that, that, you know, everybody listening today might want to consider because it happens a lot more than people realize because we didn't, people didn't know. Right. So there's another one, another thought as it relates to anybody that's disabled or chronically ill. And that is, you know, when in doubt, roll it out.

Because people can become disabled even after the fact. Car accidents happen, et cetera. And if you want to give your beneficiaries optimal flexibility, that may be a consideration. That's a great point. Yeah. Yeah. You know, I would say the third thing is the real home run though. This is my absolute favorite. So for anyone who has high net worth clients or who is interested in getting into that market,

All you have to do is ask one differentiating question that's going to disturb that prospect or disturb that client. Here's what the question is.

Does it make sense to pay tax on a tax? And of course they're going to be like, what do you mean by that? And here's what we mean. Let me give you a case. Let's say that we have a client business owner. Let's say, let's say his name is Dan and Dan has a business. He's 65 years old and he's working his tail off. So stressed out. He's, he's, and, and unfortunately all the stress, it kills him. He dies very suddenly.

His wife, Beth, has, you know, and by the way, this net worth is call it $40-$50 million. So they've got a taxable estate. Of that estate, $5 million is in a retirement account. So Beth takes a spousal rollover. She's an ed. She doesn't have to take required minimum distributions, etc., etc.,

And she lives and typical, you know, let's say that she earned 7% on this retirement account. So $5 million becomes $10, $10 becomes $20. Then she dies. So she leaves it to her kids. Her kids don't receive $20 million because, of course, that $20 million is in the taxable estate. So it's subject to the 40% estate tax. So $8 million goes off the top.

The kids, it's a pre-tax IRA, are subject, they are NEDs, so they are subject to both the 10-year and the RMDs. Let's assume that whacks out another 30%. So they're $3.2 million. So basically that $20 million pre-tax IRA that it growed to nets out to the kids at about eight. Okay. Now,

Let's not do that because what was I talking about in terms of paying tax on a tax? If let's say we go back to Dan, okay, you're Spider-Man, okay? You go back to Dan and say, Dan, let's not pay a tax on a tax. Let's do a Roth conversion of the $5 million. And Dan says, Spider-Man, what are you talking about? I'm in a 37% tax bracket. I'm a very high...

I understand. Let me walk you through this math. So he does the Roth conversion and a $5 million, $2 million goes to income taxes. What have we done? We've removed $2 million from the taxable estate if he died right away.

We've also removed the growth of that from his taxable estate. Okay, so that can be significant. So let's net out the taxes. So now Beth has $3 million. She's 65, double, double. Three becomes six, six becomes 12. $12 million in a Roth IRA. The kids then inherit that Roth IRA, okay?

This is where it's really going to sound like a late night infomercial. But wait, there's more. Yes, it's a Roth. Yes, it's tax free. Yes, the kids are going to inherit it. Number one, remember, it could have been worth $20 million. You say, why in the world would we ever do that? Well, remember that $8 million difference between the 20 and the 12, that's not subject to the 40% estate tax. But it gets even better than that. Here's why.

Because it's in a Roth, there's this quirky little loophole in this new legislation that basically says that if an inherited IRA is in a Roth, it is deemed to have – that the owner will be deemed to have died before their RBD. She's 85.

So what that means is the kids can leave it in the Roth inherited IRA, not take anything from years one through nine and take the money out in year 10, tax-free by the way, it just loses the shelter. Right. So they could definitely get a lot of compounding to do its magic before. Yeah. Exactly. Exactly. So these are the things where, again, let's keep it simple, understand where the exposure is.

where the liability is, and really let's help our clients make good decisions about their retirement accounts. Does it make sense to stay in a qualified plan? Does it make sense to stay in a pre-tax IRA? What is their goals? What's important to them about their money?

Tell me about the family. Are you leaving it to siblings? Well, then we don't have to worry about, you know, their, their ads, right? They, they can, they can continue to do RMDs based on their life expectancy. So there's lots of, lots of questions to ask. And I find that when you ask the right questions, people can sense that you really care about them and really optimizing their,

what they worked so hard to accumulate. Yeah, and I like too how you just, even walking them through the numbers, they might at first blush, oh boy, it's a big short-term hit, but you just put out, okay, there's this scenario and this scenario, and then it can go, oh, okay, like you're...

And, you know, I would imagine that a lot of people listening to us today might be glazing over just like our clients do. I find that sometimes when you document it, you kind of put it side by side and say, here's option one, here's option two. Totally up to you, your choice. What do you want to do?

We're going to give you the information that you might want and need to make a decision that's right for you and your family. Exactly. That's what we do. No, I love the deep dive and it's clear that you're incredibly knowledgeable and animated by the topic. So I think that's great. Well, you know, as with anything, I find the more you dig, the more you get into this, the more interesting it becomes and the more value we can add. Yeah.

And there's so much to know about what we do, you know, and the value that we can provide to our clients. Yeah, I mean, things like this, again, they may seem dry, but they're really important different financial outcomes based on the asset location and the tax strategy, the estate planning. It's all definitely important to get right. And I think for me, what I get from my clients is,

Again, you know, it's one thing to say that we care, but when we lay something like this out and take the time to help them to understand and process using words that they can understand, that builds a bond they never forget. Yeah. And I think it also really helps to demonstrate value because sometimes clients say, I like my advisor, but I'm

not am i really getting my money's worth right it's a little bit nebulous and with something like this i would think there'd be much more of a sense of like wow this was just saved me a ton of money and or made me a lot of money it's it's pretty quantifiable and they might have never have gone there on their own so i think this is just another example maybe our manifestation of like a really providing value absolutely you know it's one of those things where when i'm sitting down with people with clients i say you know what

We are not going to justify our presence in your lives every quarter of every year. But what you'll find is that there may be that one idea, that one thing, that crisis. It may be related to the portfolio. It may be related to something completely random, a charity, the kids are in trouble, etc. Or just some practical advice based on our experience.

We can't put a price on that. That's right. That's true. That's true. Yeah. And having that trust. And like you said, it could be even just like a one big decision and you don't know when or how that'll happen, but that can count for a lot. Yeah. I think Greg, at the end of the day, what clients are looking for is someone who's going to help

who's going to exercise good judgment. And good judgment comes from experience and taking the time to really understand complicated issues like this inherited IRA thing. It's filled with caveats. It's filled with but this and different roles. And just to boil it down and figure out what applies to their situation and make it easy to understand.

Yeah. Well, I think you accomplished that today. Thank you. So thanks so much for joining. Thank you so much. Thanks for, thank you all for listening to this and I hope everybody has a wonderful, wonderful day and continue to prosper. Excellent. Thank you so much. My guest has been Patty Brennan. For more podcasts and the latest wealth management news, visit barons.com slash advisor. For The Way Forward, I'm Greg Bartalus.