Inherited IRA Strategy

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BogleTrainee
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Joined: Fri Nov 08, 2019 11:05 am

Inherited IRA Strategy

Post by BogleTrainee » Fri Nov 08, 2019 1:30 pm

My father recently passed away and I will be inheriting a portion of his 403(b) retirement account as a beneficiary. My portion is roughly $66,000. He was 75 and single, and already taking distributions. It looks like I only have two options:

1. Take a lump distribution
2. Take Required Minimum Distributions

The lump sum distribution doesn't seem desirable. I'm married and filing jointly, so roughly 1/2 of the proceeds will get taxed at the 22% tax rate and the other half will push me up to the 24% tax bracket. If my calculations are correct, I would have to pay an additional $15K in federal taxes this year. I live in Illinois, and as far as I can tell there is no state tax on IRA disbursements. I don't need this money immediately, so the RMD seems like a better way to go.

The 403(b) plan lets me to specify the frequency, dollar amount, and starting date of the distribution. I currently do not max out my 401K with my employer. I only allocate 6% (~$7,000/year) just to get the maximum matching benefit. I was thinking that starting next year, it would make more sense to change my contribution to the $19,500 401K maximum. To make up for the lost take home pay, I will take a monthly distribution of $1042 from the inherited IRA. If my math is correct, it would take around 5 years to withdraw the entire inherited IRA while at the same time I will be maxing out the 401K. Are my assumptions correct in thinking that the federal taxes would be a wash and this will be the best way to avoid paying taxes today?

Silk McCue
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Re: Inherited IRA Strategy

Post by Silk McCue » Fri Nov 08, 2019 2:10 pm

Welcome to Bogleheads!

So very sorry for your loss.

What you are proposing is often recommended. Moving funds from a forced taxed distribution into a tax deferred account to avoid an increase taxes is an excellent strategy. Personally I would start that process this year using what time is left assuming that you could receive a smaller distribution this year.

If you aren't funding Roth you could consider doing that with some of the funds as well if you feel comfortable doing so in the 22% bracket. Diversification of retirement funds is a good strategy.

Cheers

delamer
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Re: Inherited IRA Strategy

Post by delamer » Fri Nov 08, 2019 3:22 pm

I am sorry about your father.

Your plan makes sense.

Are you planning on leaving the funds in the 403(b) or rolling them into an Inherited IRA?

The Inherited IRA would give you the most flexibility and might provide the better investment options.

chemocean
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Re: Inherited IRA Strategy

Post by chemocean » Fri Nov 08, 2019 3:59 pm

Does any one know if Qualified Charitable Distributions be made from an inherited IRA?
If so and you were charitably inclined, you could make your charitable contributions from the inherited IRA with no tax consequences.
Then, the taxable money you normally would allocate to charitable giving can be diverted to increase your own pension plans or to a Roth IRA.

Silk McCue
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Re: Inherited IRA Strategy

Post by Silk McCue » Fri Nov 08, 2019 4:05 pm

chemocean wrote:
Fri Nov 08, 2019 3:59 pm
Does any one know if Qualified Charitable Distributions be made from an inherited IRA?
If so and you were charitably inclined, you could make your charitable contributions from the inherited IRA with no tax consequences.
Then, the taxable money you normally would allocate to charitable giving can be diverted to increase your own pension plans or to a Roth IRA.
You can do QCDs on an inherited IRA (but can't do Roth conversions). You must be 70.5 to do a QCD however and that includes those that inherit an IRA.

Cheers

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Kenkat
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Re: Inherited IRA Strategy

Post by Kenkat » Fri Nov 08, 2019 4:13 pm

I’d just take the minimum RMD from the IRA. You have more options for investing that money than the 401k plus it is easier to tap into if by chance you did need to take more money out in the future. Once the money is in the 401k, it is hard to get back out short of taking a loan against it which is typically not advisable.

ncbill
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Re: Inherited IRA Strategy

Post by ncbill » Fri Nov 08, 2019 4:47 pm

Kenkat wrote:
Fri Nov 08, 2019 4:13 pm
I’d just take the minimum RMD from the IRA. You have more options for investing that money than the 401k plus it is easier to tap into if by chance you did need to take more money out in the future. Once the money is in the 401k, it is hard to get back out short of taking a loan against it which is typically not advisable.
Yep, do the minimum annual RMD & let it grow over your lifetime...there's no need to cash out over 5 years.

That way, as another poster noted, you can also use it for charitable giving once you reach 70.5.

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Eagle33
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Re: Inherited IRA Strategy

Post by Eagle33 » Fri Nov 08, 2019 9:02 pm

Silk McCue wrote:
Fri Nov 08, 2019 4:05 pm
chemocean wrote:
Fri Nov 08, 2019 3:59 pm
Does any one know if Qualified Charitable Distributions be made from an inherited IRA?
If so and you were charitably inclined, you could make your charitable contributions from the inherited IRA with no tax consequences.
Then, the taxable money you normally would allocate to charitable giving can be diverted to increase your own pension plans or to a Roth IRA.
You can do QCDs on an inherited IRA (but can't do Roth conversions). You must be 70.5 to do a QCD however and that includes those that inherit an IRA.

Cheers
+1

OP's father would have been 14 if OP is 70.5 now!?
Rocket science is not “rocket science” to a rocket scientist, just as personal finance is not “rocket science” to a Boglehead.

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celia
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Re: Inherited IRA Strategy

Post by celia » Fri Nov 08, 2019 9:41 pm

BogleTrainee wrote:
Fri Nov 08, 2019 1:30 pm
It looks like I only have two options:

1. Take a lump distribution
2. Take Required Minimum Distributions
3. Roll the 403b to an Inherited Traditional IRA and take out more than the Required Minimum Distributions each year but less than emptying out the account. The amounts can vary each year as long as the RMD is removed.


We don't know how old you are and how much you have in all your tax-deferred accounts. But if you might be in a situation where your post-age-70.5 tax bracket is higher than now (and higher than in early retirement), you should consider doing Roth conversions during your early retirement (pre-age-70.5) years.

In that case, having this inherited 403b/IRA with its RMDs still around, those RMDs could take up the space you might need for Roth conversions instead.

So if you are currently over age 50, it may be time to roughly estimate your income and tax bracket for the next 20+ years.

For example, here is our story (short version):
We started doing Roth conversions while still working and continued them when retired and under age 70, since we projected we had enough income from our pensions and future SS to more than cover living expenses. We were on track to have all tax-deferred accounts converted by age 70, when DH inherited a large tax-deferred IRA in his mid-60s. Then we saw that we could either continue our Roth conversions while only taking the RMDs from the Inherited IRA, or we could lower our conversion amounts in the remaining years while drawing down more than the minimum from the Inherited account. We ended up compromising somewhere in the middle but knew that our own tIRAs could be converted for our heirs whereas the Inherited IRA withdrawal couldn't be converted. Now that we are over 70.5, the remaining amounts in both kinds of accounts are being given to charity via Qualified Charitable Distributions (QCDs), where neither the charity nor we have to pay taxes on the withdrawals.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

nix4me
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Re: Inherited IRA Strategy

Post by nix4me » Fri Nov 08, 2019 10:13 pm

Just take the money and pay the taxes. if you need it, spend it. If not, invest it in a taxable account. Giving money away to keep from paying taxes is dumb.

Silk McCue
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Re: Inherited IRA Strategy

Post by Silk McCue » Fri Nov 08, 2019 10:38 pm

nix4me wrote:
Fri Nov 08, 2019 10:13 pm
Just take the money and pay the taxes. if you need it, spend it. If not, invest it in a taxable account. Giving money away to keep from paying taxes is dumb.
If you gave to charity in a significant way, as many here do, you would understand why the QCD discussion might have been an option. No one was suggesting to give it away to avoid taxes as the primary motivation.

Cheers

lakpr
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Re: Inherited IRA Strategy

Post by lakpr » Fri Nov 08, 2019 11:08 pm

@BogleTrainee,

I fully agree with your strategy of maxing out your retirement accounts (401k or 403b) every year, and in turn draw living expenses from the Inherited 403b. Doing so, you will have effectively moved the Inherited funds into your own retirement account where the RMDs are not due until the year you turn 70.5. I would also suggest maxing out your Roth IRAs (including spouse here, if you are married) if you weren't already doing so

The better suggestion is also offered above, to roll that 403b over into an Inherited IRA so you are not locked into specific amounts per withdrawal and frequency of withdrawals. The IRA custodian will be able to calculate the RMD on an annual basis and distribute it in equal monthly installments if you so desire, and of course you can always draw more from the account than the required minimum.

I do not agree with the suggestion offered in one of the posts above that you should simply draw down only the RMD and let the amount grow through your lifetime. At the bare minimum, it complicates the life of your own successor beneficiaries. If you were to pass, your successors cannot reset the RMD schedule to their own life expectancy on inheriting an Inherited IRA. They must continue with your own life expectancy schedule and thus face higher minimum withdrawals than if you have transformed the money from inherited IRA indirectly into your own retirement account (401k or 403b or IRA)

Of course, you can take the line that you don't care what happens to the money when you are pushing up the daisies. Apart from the mild criticism that you would not be "paying it forward" the same favor your benefactor did for you, I wouldn't find too much fault with that line of reasoning either.

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Watty
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Re: Inherited IRA Strategy

Post by Watty » Fri Nov 08, 2019 11:41 pm

BogleTrainee wrote:
Fri Nov 08, 2019 1:30 pm
Are my assumptions correct in thinking that the federal taxes would be a wash and this will be the best way to avoid paying taxes today?
Probably but it would be good to do a dummy tax return including your state income taxes to make sure that you are not in some unusual situation where it makes a difference.

Your plan makes sense but one downside is that if you retire before the age of 59.5 then the inherited IRA would be an easy way have access to money without paying an early withdrawal penalty. There are other ways to work around that but you would have a lot of flexibility with the inherited IRA. The inherited IRA would also provide more flexibility if you are laid off, disabled, or something like that.

Another possible downside is that if you move the money into the 401k and then get divorced then that money might be split in the divorce. If it was left in the inherited IRA then it might be considered your asset and not split in a divorce. This can vary a lot with your state laws.

One other thing to look at is if you have good low cost mutual funds in the 401k. If the expenses are higher in the 401k then I would not be in a hurry to move the money into a 401k.

Topic Author
BogleTrainee
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Joined: Fri Nov 08, 2019 11:05 am

Re: Inherited IRA Strategy

Post by BogleTrainee » Mon Nov 11, 2019 5:24 pm

Wow, thanks for all of the helpful suggestions everyone! You've given me a lot to think about. I'll definitely look into opening an inherited IRA, I already have accounts with Vanguard so that's a no-brainer.

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