Q: Back in 2013, I inherited my younger brother’s IRA. He was 73 when he died. I was 6 years older than him. Since 2014, as advised by my bank, I’ve taken out my required minimum distributions (RMD) based on my life expectancy, not his. However, this year my bank has calculated my RMD based on my brother’s life expectancy, not mine. Can you clear this up for me? 

A: You’ve presented a rather interesting case. The quick answer is your bank is now finally giving you correct advice regarding your required minimum distribution or RMD. I emphasize the word, finally, because for the past 9 calendar years you’ve distributed and paid tax on more than was required. This is both unfortunate and irreversible. 

To start, the rules did change in 2020 for many IRA beneficiaries. Prior to 2020, non-spouse IRA beneficiaries were allowed to “stretch” their RMDs over their life expectancy. After 2020, most non-spouse IRA beneficiaries are now forced to distribute their inherited IRA balance within 10 years. 

Since your brother died in 2013, you get to keep using the old “stretch” rules. At first blush, the bank would appear correct in using your life expectancy to calculate your RMD. However, there was an added wrinkle that your bank overlooked. Given that your brother had already begun taking his required minimum distributions each year, your subsequent Inherited IRA distributions should have been based on his younger age, not yours. 

Let me demonstrate the impact. Since he was 73 years old at the time of his death, his life expectancy using the IRS’s life expectancy table (which was updated in 2021) was 16.4 years. The rule states that for all subsequent years, you need to subtract 1 year from his original life expectancy and then divide each year-end account balance by that adjusted life expectancy figure. 

For 2014, your first divisor should have been 15.4 or one less than his original life expectancy of 16.4. Now, fast forward all the way to 2023. Your RMD this year should be calculated as your 2022 year-end account balance divided by 6.4, which is now ten less than his original life expectancy. Yes, this is a hefty 16% of your account, but it’s much better than being forced to distribute a truly massive 35% of the account using your age. In the end, I’m very glad the bank is now getting it right.

For interested readers, you can review the Inherited IRA distribution rules on page 10 of the IRS Publication 590-B or by visiting www.FrontStreet.com/InheritedIRA. This link will automatically forward you to an IRS page that does a good job of explaining the rule.

Q: I was talking to a friend the other day. She told me I am allowed to rollover some of my IRA to my Health Savings Account. Is this really allowed? Please explain.

A: Your friend is absolutely right. But, as is the case with most things in the world of money and taxes, there are some key things to understand and a few rules to follow.

If you are eligible, once in your lifetime you are allowed to do a rollover of part of your IRA into a Health Savings Account, most often referred to as an HSA. Note the three phrases, if you are eligible, once in your lifetime and part of your IRA.

To be able to do an IRA-to-HSA rollover, you have to be enrolled in an HSA-eligible health plan during that tax year. HSA-eligible plans are also referred to as  high-deductible health plans. To prevent wasting your time, be sure to investigate your health plan first to see if you can even consider a rollover.

If you do qualify, make sure you’re pretty confident you’ll be enrolled in an HSA-eligible health plan for a full 12 months following the date of your IRA-to-HSA rollover. If you fail this one-year eligibility test, you’ll end up having to pay income tax on the IRA distribution. Adding insult to injury, if this happens and you are under age 59.5, you’ll even have to pay a 10% tax penalty for taking an early withdrawal.

Now, once in your lifetime you are only allowed to rollover up to the maximum HSA contribution amount for the year. In 2023, a single person can contribute up to $3,850 to an HSA and a married couple can contribute up to $7,750. If you are over age 55, you can tack on another $1,000. And, if you want to rollover the maximum amount allowed, just know that any other contributions made to your HSA during that same year need to be factored in. Please note, if you are married, you and your spouse can each do an IRA-to-HSA rollover.

Why is this IRA-to-HSA move such a good thing? Well, given that your IRA is most likely funded with pre-tax money, eventually you’ll have to pay income taxes on your IRA money. That was the trade you made when you took the tax deduction on your taxes. With this one-time, limited size IRA-to-HSA move, you are able to transform money that enjoyed a tax break into money that will never be taxed. Of course, that’s only true if you end up having health care expenses. No worries, that’s a bet I’m sure we all can make!

Jason P. Tank, CFA, CFP® is both the owner of Front Street Wealth Management, a purely fee-only advisory firm and the founder of the Money Series, a non-profit program committed to providing open-access to financial education, for all. Contact him at (231) 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com

Q: For the first time ever, my tax preparer has asked us to make estimated tax payments each quarter. Can you help me understand why this is important?

A: Having to make estimated tax payments for the first time can be a little perplexing. Most people are used to paying their taxes through some sort of automatic “tax withholding” mechanism, such as your wages, IRA, pension, or Social Security.

Some people, however, receive income that isn’t subject to any tax withholding. Of course, the government still expects you to pay taxes on that income evenly throughout the year. Examples of this type of income might include self-employment income, rental income, interest, dividends or capital gains.

Generally-speaking, to satisfy the government, you need to pay at least 90% of your tax obligations for the year or, alternatively, 100% of your prior year’s tax. If you fail to pay these minimum levels of taxes, you could end up paying both interest and penalties.

To avoid this, you should follow your tax preparer’s advice and use your vouchers to pay those estimated quarterly tax payments by the due dates.

Q: With last year’s decline in bonds rivaling the drop in stocks, I’m really wondering if they even make sense for me. What’s the upside of keeping them in my portfolio?

A: When you invest in bonds, you are basically acting as the bank. You are lending money on set terms; the interest rate you’ll earn and when you’ll get your money back. These things are written in stone, so to speak, and normally this makes bonds a much steadier segment of a balanced portfolio.

Like stocks, however, bonds also trade in the open market. This means that bonds can and do fluctuate in value. Last year, bond prices declined way, way more than usual!

In quick fashion, the Fed hiked interest rates. This made your stale, old bonds far less attractive than brand new bonds with their glimmering higher interest rates. As a result, investors did some math and, voila, your bonds fell in value. In fact, they declined  just enough to put your old bonds on financially-equal footing with those brand new bonds.

Now, the bigger and faster the change in interest rates, the greater the price change for your old bonds. The change in interest rates was both very large and very fast.

But, given the set terms of bonds, you should know that the expected total return for your bond portfolio is now significantly higher. For this reason, I think the benefits of holding bonds as part of a balanced portfolio are even greater than before. And, yes, I’m fully aware that this feels like small consolation!

Believe it or not, this year is now officially halfway over! This means you don’t have a ton of time left to think about your planned charitable giving. To spur you along, here are some old giving methods along with a new one that just might fit the bill

Appreciated Securities: If you own a stock that has significantly appreciated in value, you might consider donating some shares directly to a qualified charity. With your donation, you will avoid ever having to pay the capital gains tax. Better yet, your chosen charity won’t get taxed, either. And, if you itemize your deductions on your taxes, you stand to receive a tax break. Of course, given that so many people now opt for the super-sized standard deduction, it’s important to consult your tax advisor to see if your donation will actually result in a tax break.

Donor-Advised Fund: To help you get a tax break, you might consider “bunching up” multiple years of your planned giving through a donor-advised fund. From your new donor-advised fund, you can then take all the time you need to donate the money. Think of this as setting up your very own foundation on the cheap and with very few administrative headaches. Most brokerage firms make donor-advised funds really easy to start.

IRA Donations: For those over the age of 70 ½, you are allowed to donate directly to charity right from your IRA. Normally, when you take money out of your IRA, it’s taxed as ordinary income. However, if you donate the money directly to a qualified charity, you get to exclude those distributions on your tax return. For those who face required minimum distributions each year, using your IRA as a charitable tool is an especially tax smart way to give.

Charitable Gift Annuity: While these have been around for some time, a new version of charitable gift annuities is worth highlighting. To begin, with a charitable gift annuity, your charity gets the money right away and they simultaneously agree to send you periodic payments in return. After some fancy figuring is done, you are entitled to a tax deduction for a portion of your donation. Starting in 2023 under a new tax law, people over age 70 ½ can also establish a charitable gift annuity using their IRA. Importantly, unlike a normal charitable gift annuity, 100% of your donation is deductible on your tax return and it also counts toward your annual required minimum distribution. For some people, this new IRA charitable gift annuity might open up some particularly interesting tax planning opportunities.  

Q: I’ve heard a recent law, known as Secure 2.0, created some interesting possibilities for leftover money held in 529 plans for college savings. Namely, the new law seems to allow you to rollover the unused 529 plan balance into a Roth IRA. How does this work?

A: Among the many changes that Secure 2.0 created to enhance retirement savings, Congress did establish some new rules for college savings plans, commonly known as 529 plans.

Starting in 2024, leftover 529 plan balances can now be rolled over into a Roth IRA for the plan’s named beneficiary. However, the new law lays out a number of rules that diminish the planning opportunity.

To start, in order to be allowed to do a 529 plan-to-Roth IRA rollover, you’ll need to have started the college savings plan at least 15 years prior. Naturally, to get this countdown started, you should open a 529 plan for your kids or grandkids as soon as possible.

Next, you are limited in the amount that can even be rolled over into a Roth IRA. The overall limit for a 529 plan-to-Roth IRA rollover is $35,000.

Further, you aren’t allowed to do this amount as a one-time rollover. Instead, the annual rollover limit is set at the normal IRA contribution maximum. Today, that annual IRA contribution limit is $6,500. To reach the $35,000 lifetime limit, it will obviously take multiple years of planning.

And, finally, the only dollars that are eligible for a 529 plan-to-Roth rollover are those that have been invested in the 529 plan for at least five years.

Q: With our federal debt continuing to grow, it seems that tax rates are going to increase in the years ahead. It’s got me seriously thinking about doing some substantial Roth conversions. What factors should I consider before pulling the trigger?

A: I must admit, it’s difficult to argue that tax rates are going to decline in the future! Given this, Roth conversions should certainly be top-of-mind.

But, a comprehensive Roth conversion analysis isn’t as straight-forward as simply guessing about future tax law changes. There are multiple considerations and peculiarities that can substantially raise the cost of Roth conversions.

For example, you should be aware of the possible tax effect that Roth conversions can have on the taxation of your Social Security benefits.

In addition, in the case of large Roth conversions, you’ll also need to watch out for a lesser-known wrinkle lurking in the tax code called the Net Investment Income Tax.

And, of course, another important consideration is pushing your income so high that it results in you having to pay higher premiums for your Medicare Part B benefits.