Trying to make sensible allocation for inheritance

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Ken Reckers
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Trying to make sensible allocation for inheritance

Post by Ken Reckers » Fri Apr 20, 2007 11:37 am

We have an inherited IRA to invest, and I'm having trouble figuring out
how to make a sensible allocation for it.

Distributions must begin immediately, and we plan on taking the minimum.
Turning age 44 this year means withdraw 1/39.8 of it, about 2.5%, this year.

The unknown factor is whether or not we need to use any of it, for college
for example. Is it possible to make a good (not perfect) allocation plan
with that much uncertainty? We want a plan for the inherited IRA and for the
distributions.

If not, could we make a sensible plan by making assumptions,
to reduce the uncertainty at least somewhat? Assume that the best case
scenario is that we can save the full amount, including the required
distributions, for retirement. What if we assume that the worst case
scenario is that we will need to use the required distributions but won't
have to tap into the rest. (Of course, the real worst case scenario may be
that we need to tap into more than the required minimum.)

More background:

Our ages: 44
Children about 12 and 10.

To get an idea of our risk tolerance: For several years our retirement
allocation has been 83/17 stock/bond. (The target has been 80/20,
but we only check it quarterly, and we only rebalance if it strays plus or
minus 5. Basically we have just been directing new contributions to bonds,
and we haven't had to rebalance since 2003 or so.)

If added to the entire retirement portfolio, the inherited IRA will be
15% of the total value.

Tax bracket is 15%.

Salary is extrememly stable, just not high. Plenty of emergency savings,
plus extra to boot. (Our risk tolerance for our non-retirement savings
is almost the opposite of that for our retirement. Only about 35% of the
non-retirement savings is stock, the rest bond/I-bonds/CD's/MM.)

The college savings are good, not great.

The deceased's IRA is currently in individual stocks. Thus, I don't
believe I should think of it as a lump sum of cash. We will want to
invest it in one or possibly two mutual funds, depending on what
allocation plan we decide on.

I'm just having trouble getting a good "mental image" of how to
think of this inherited IRA and its future distrubitions. As part of
our retirement portfolio, as a separate portfolio, or what. And then
do we allocate it as if we were accumulation investors, transition investors,
distribution investors (earlier or later years), or lump sum investors
(growth or income oriented) (using the labels from Bogle on Mutal Funds).

Thanks for reading. Any comments are welcome. (Just writing it out
has helped me gain some clarification.)

"Ken"

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LarryG
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Ken

Post by LarryG » Fri Apr 20, 2007 1:47 pm

If this were me,I would think of the inherited IRA as part of a retirement portfolio.

I would sell the individual stocks in the IRA and place the proceeds in a bond fund, such as the total bond market index fund. If this causes the desired asset allocation to be too heavy in fixed income, future contributions can be directed to equities

You might consider 529 funds for your children and you can place the required distributions from the IRA into those funds.

Good Luck

Larry G.

tnlsea
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Post by tnlsea » Fri Apr 20, 2007 2:19 pm

**Deleted**
Last edited by tnlsea on Fri Nov 02, 2007 4:25 pm, edited 1 time in total.

mptfan
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Post by mptfan » Fri Apr 20, 2007 4:30 pm

tnlsea wrote:"Ken",

My Inherited IRA is pretty much the lowest returning portion of my retirement portfolio (bonds), as the amount of the RMD is based on the account value at the end of the previous year. I want this to grow as slowly as possible, so that the RMD (and related taxes) are at a minimum.

- Tom
I have never understood this line of thinking. Why would you want to earn less money just because you would owe more taxes? That makes no sense to me.

Think of it this way, if I offer to give you $100, with the proviso that out of every $100 that I give you, you have to give $25 of it to my family member (uncle Sammy), and you get to keep $75. Is that a good deal? Would you decline my offer?

Wagnerjb
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Post by Wagnerjb » Fri Apr 20, 2007 4:30 pm

Ken: My wife inherited an IRA several years ago, and we are both in our 40's. We consider the inherited IRA as part of our long-term retirement assets, although it is a tiny fraction of our nest egg.

We have a large 401k balance and a large taxable balance, but a much smaller IRA balance. Since REIT isn't available in the 401k - and putting it in taxable would be unwise - we have the inherited IRA in REIT.

I would like to second the suggestion to sell the individual stocks immediately before they accumulate taxable gains that will cause you to reconsider the wisdom of selling them.

Even if you think you will use the funds in the IRA for college, I suggest you consider using other taxable funds if possible. If you use the IRA funds, you have to take a taxable distribution to pay for college. In addition, you forfeit the IRA space which prevents you from using that capacity for future tax-deferred compounding. If you use taxable funds, you generate no income when you source funds for college and you preserve the IRA space.

Best wishes.
Andy

Target2019
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Post by Target2019 » Fri Apr 20, 2007 5:05 pm

The idea of taking the RMD and investing in a Roth or a 529 plan is a great idea.

You don't have to sell the stocks. In fact, that may be the worst idea. But without knowing what the stocks are, no one can really say.

Do you have any sense of how the portfolio has performed in the past?

Nitsuj
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Post by Nitsuj » Fri Apr 20, 2007 5:20 pm

mptfan wrote:I have never understood this line of thinking. Why would you want to earn less money just because you would owe more taxes? That makes no sense to me.
If the overall AA includes the bond portion herein within the desired percentage for fixed income investments, it makes some sense. Doesn't it?

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stratton
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Post by stratton » Fri Apr 20, 2007 6:07 pm

If the overall AA includes the bond portion herein within the desired percentage for fixed income investments, it makes some sense. Doesn't it?
Yes, you're giving it an annual haircut every year by taking RMDs out. If you put a bit equities in there (say 30 to 40% like Wellesley) you can get some growth out of your inherited IRA too.

I've got the same situation too. Mine iherited IRA with RMDs is equivalent to 3.5% of my asset allocation. I'm planning on putting some REITS in it so I can open up space in my main IRA/Roth accounts. 1% of my main asset allocation in REITs will fill up about 30% of the IRA and the REIT's dividends can help fuel the RMD. The rest of it I'm still thinking about.

Paul

Ken Reckers
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Post by Ken Reckers » Fri Apr 20, 2007 10:18 pm

It never even occurred to me to invest the entire inherited IRA as bonds, but it does make sense, given that it would represent 15% of the entire retirement portfolio, and our target bond allocation would be 20%. Thus, on the same day we invest the inherited IRA in a bond fund, we could reallocate that same amount of my Roth IRA from bonds into a stock fund. The overall allocation would remain the same, but if *something* has to be in the account that has to have a "haircut" every year, it might as well be bonds. (If the inherited IRA were larger than 20%, then of course I would not invest it all in bonds.)

It looks like everyone would think of it as part of the entire retirement portfolio, so thank you for that feedback. This will give me a useful framework. I like the idea of "saving the IRA space" by not tapping into the tax-deferred portion for college, if possible. We'll still have to decide what to do with the RMD's--direct to a 529, or invest in Roth, or other.

I don't know the exact way the deceased's IRA currently is invested in stock, and I don't know how it has been performing. I don't want to own individual stocks. Wouldn't a working substitute be simply to pretend that it was Total Stock Market, since I don't know the exact investments? I can keep the same stock position, approximately, if I convert the inherited IRA to bonds and, at the same time, convert an equal amount of Roth bonds to stocks, right?

I would be happy just to have the inherited IRA set up initially in a way that is not a mistake, allowing the possibility to reallocate later this year after further digesting the options.

Thank you very much for all of the thoughful comments.

"Ken"

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Post by Spirit Rider » Fri Apr 20, 2007 10:26 pm

tnlsea wrote:My Inherited IRA is pretty much the lowest returning portion of my retirement portfolio (bonds), as the amount of the RMD is based on the account value at the end of the previous year. I want this to grow as slowly as possible, so that the RMD (and related taxes) are at a minimum
mptfan wrote:I have never understood this line of thinking. Why would you want to earn less money just because you would owe more taxes? That makes no sense to me.
Nitsuj wrote:If the overall AA includes the bond portion herein within the desired percentage for fixed income investments, it makes some sense. Doesn't it?
Actually, it not only makes sense, it is the optimal way to handle this situation. You need to look at 'all' the assets as one unfied portfolio, with optimal location of asset types.

Here is the situation, there are three classes of investments.
A - Non-retirement assets
B - Retirement assets requiring no distributions
C - Retirement assets with RMD

You want to manage this to give you the most tax-advantaged benefit. You are 'not' earning less money to save on taxes. You are deciding 'where' to earn the the money for the most benefit.

For the three classes of investments.
A - Most tax advantaged assets(individual stocks, etfs, index funds, and tax managed funds)
B - REITs, stocks funds with high divedends/gains, fixed income.
C - Lowest yielding fixed income.

This is not a case of leaving 'any' money on the table because of tax issues. It is matter of placing assets in the right bucket to grow your overall assets in the greatest tax deferred/managed manner. Allocating your portfolio(assuming to have the necessary space in the three buckets) in a manner to get the smallest RMD from the inheritd IRA is the smartest way to manage this. You will receive the smallest distribution and pay the smallest tax at your top marginal rate.

I have an inheritd IRA which has total bond index and a TIPS fund. I trade this off by having index funds in my taxable account, and assets that would through off signicant taxable income in my retirement accounts. This gives me the smallest RMD from my overall portfolio and thus the smallest tax byte. Also, this allows the overall portfolio to grow to its maximum potentional.

mptfan
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Post by mptfan » Sat Apr 21, 2007 7:11 am

Thank you to those who pointed out that I had not considered all of the tax implications of putting different asset classes into different types of accounts in order to maximize the tax benefit of RMDs. I am too young to worry about RMDs, and I don't have an inherited IRA, so those issues hadn't occured to me.

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WiseNLucky
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Post by WiseNLucky » Sat Apr 21, 2007 7:20 am

Nitsuj wrote:
mptfan wrote:I have never understood this line of thinking. Why would you want to earn less money just because you would owe more taxes? That makes no sense to me.
If the overall AA includes the bond portion herein within the desired percentage for fixed income investments, it makes some sense. Doesn't it?
Yes, and on two levels. First the reason mentioned - that of allowing the slowest increase in the portfolio balance to reduce RMDs. The second reason is that having fixed in the IRA means that you are keeping the tax treatment consistent. Why pay ordinary income taxes on capital gains when you could defer them in a taxable account? You will eventually have to pay ordinary income tax rates on bonds -- do it through RMDs since you can't avoid the tax anyway.
WiseNLucky

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