Inherited IRA: Using it for kids college

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llessac15
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Inherited IRA: Using it for kids college

Post by llessac15 » Thu Jun 14, 2018 10:35 pm

My wife is inheriting a low 6-figure IRA from her recently deceased father. From what I understand, it is best just to leave it alone and receive RMD’s from it for now. I was hoping to use it to invest for my three very young kids college tuition. The only way I see this happening is either taking the lump sum and placing the after-tax amount in my 529 accounts, or sending the RMD’s to the 529 accounts each year. I am in the highest tax bracket so I don’t see the lump sum option as a good one given the enormous tax hit I would take.

Any thoughts or recommendations?

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Re: Inherited IRA: Using it for kids college

Post by bsteiner » Thu Jun 14, 2018 11:07 pm

If you're in the top bracket, your taxable income is over $600,000, so you'll probably have other money to pay for your children's education.

So why not stretch the IRA and take only the required distributions each year?

She may also want to consider disclaiming the IRA if your children are the contingent beneficiaries. That would provide a much longer stretch.

If your children are the contingent beneficiaries, you should check to see whether their shares would be payable to a custodian under the Uniform Transfers to Minors Act under the beneficiary designation. If not, most states permit someone holding property of a minor (the financial institution holding the IRA) to pay it to a custodian up to a specified amount. The amount varies from state to state. You should check to see whether each child's share is within that amount under the law of any available state, and if so, whether the financial institution would be willing to set up inherited IRAs with you as custodian.

mhalley
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Re: Inherited IRA: Using it for kids college

Post by mhalley » Thu Jun 14, 2018 11:07 pm

Funding 529s with the rmds seems like a good idea, unless you are not maxing out all your retirement accounts, which comes before college funding.

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Re: Inherited IRA: Using it for kids college

Post by AlwaysWannaLearn » Thu Jun 14, 2018 11:14 pm

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Re: Inherited IRA: Using it for kids college

Post by letsgobobby » Thu Jun 14, 2018 11:20 pm

llessac15 wrote:
Thu Jun 14, 2018 10:35 pm
My wife is inheriting a low 6-figure IRA from her recently deceased father. From what I understand, it is best just to leave it alone and receive RMD’s from it for now. I was hoping to use it to invest for my three very young kids college tuition. The only way I see this happening is either taking the lump sum and placing the after-tax amount in my 529 accounts, or sending the RMD’s to the 529 accounts each year. I am in the highest tax bracket so I don’t see the lump sum option as a good one given the enormous tax hit I would take.

Any thoughts or recommendations?
This seems unnecessary. As others have suggested, mentally earmark the inherited IRA as a college fund. Invest it as you would the assets in a 529. Take the RMDs and contribute them to a 529.

llessac15
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Re: Inherited IRA: Using it for kids college

Post by llessac15 » Fri Jun 15, 2018 5:07 am

Thanks for the replies. I will plan to use the RMD’s to invest into the 529’s and also earmark the total iIRA to be used for college if needed.

livesoft
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Re: Inherited IRA: Using it for kids college

Post by livesoft » Fri Jun 15, 2018 6:10 am

What does your spouse want to do with the money? Although, I am against sentimental and emotional attachments to money, maybe your spouse is not?

If you are going to move the IRA money to 529 plans, then I suggest that you open new ones AND your spouse is the owner and not you. Of course, the gains will be tax-free in the 529 if used for college, whereas the same gains in the IRA will be taxed heavily. Do you see why I suggest the 529 owner is your spouse?
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Re: Inherited IRA: Using it for kids college

Post by Grt2bOutdoors » Fri Jun 15, 2018 6:27 am

livesoft wrote:
Fri Jun 15, 2018 6:10 am
What does your spouse want to do with the money? Although, I am against sentimental and emotional attachments to money, maybe your spouse is not?

If you are going to move the IRA money to 529 plans, then I suggest that you open new ones AND your spouse is the owner and not you. Of course, the gains will be tax-free in the 529 if used for college, whereas the same gains in the IRA will be taxed heavily. Do you see why I suggest the 529 owner is your spouse?
+1
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aristotelian
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Re: Inherited IRA: Using it for kids college

Post by aristotelian » Fri Jun 15, 2018 7:49 am

"Using it for kids college" is mental accounting. Money is fungible so there is no need to use these funds for a particular purpose. How you liquidate the IRA and whether/how to fund the 529 are separate questions. I would just do RMD's as you have proposed, then contribute as much as you can to the 529's from whatever funds you have available.

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Re: Inherited IRA: Using it for kids college

Post by Grt2bOutdoors » Fri Jun 15, 2018 7:58 am

aristotelian wrote:
Fri Jun 15, 2018 7:49 am
"Using it for kids college" is mental accounting. Money is fungible so there is no need to use these funds for a particular purpose. How you liquidate the IRA and whether/how to fund the 529 are separate questions. I would just do RMD's as you have proposed, then contribute as much as you can to the 529's from whatever funds you have available.
The inheritance is to the wife, not the OP. You can make suggestions about what to do with it, but you can not tell the person who's actually inherited it how to spend it. Money is not fungible when it belongs to an individual other than the one asking the question.
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Re: Inherited IRA: Using it for kids college

Post by aristotelian » Fri Jun 15, 2018 8:31 am

Grt2bOutdoors wrote:
Fri Jun 15, 2018 7:58 am
aristotelian wrote:
Fri Jun 15, 2018 7:49 am
"Using it for kids college" is mental accounting. Money is fungible so there is no need to use these funds for a particular purpose. How you liquidate the IRA and whether/how to fund the 529 are separate questions. I would just do RMD's as you have proposed, then contribute as much as you can to the 529's from whatever funds you have available.
The inheritance is to the wife, not the OP. You can make suggestions about what to do with it, but you can not tell the person who's actually inherited it how to spend it. Money is not fungible when it belongs to an individual other than the one asking the question.
Sure, although some married couples have joint finances, so assuming the money was not used for a new purpose, yes, it is fungible. My assumption is wife is on board with saving for kids college and OP has not indicated otherwise. Even so, the fact that the money belongs to the wife is all the more reason not to think of it as "using it for kids college".

llessac15
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Re: Inherited IRA: Using it for kids college

Post by llessac15 » Fri Jun 15, 2018 3:16 pm

Thanks again for all the responses. My wife doesn’t have any care about the money at all. She asked me to just do whatever I think is best with the money. I need to sit down and do the math on lump sum now with a three way split into the 529’s for tax free growth, or do the RMD/let it sit and grow route.

As far as earmarking it for college, that’s just how I do things with my finances. It doesn’t usually make a difference financially, but it gives me peace of mind. I have “earmarked” each of our Roths (kids inheritance), our taxable (early retirement), and our 401k (life after 70) for different purposes. It keeps me organized in my head.

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Re: Inherited IRA: Using it for kids college

Post by 47Percent » Fri Jun 15, 2018 5:16 pm

The whole point of 529 is tax deferred growth and tax free withdrawal.

IRA gives you tax tax deferred growth, but withdrawal is taxed.
But withdrawal is going to be taxed now or later and it is usually a black art guessing which is better. But in your case, you say you are in a high tax bracket. Unless you expect to be in an even higher tax bracket later, it is probably better to leave it in. Lump-sum taxable withdrawal is never a good idea as you will end up in a high bracket even if you are not in one currently.

Anyway, you will have to take the RMD.

So, you already have the investment vehicle you need.

Adjust the investments within IRA towards college in mind. You can even create 3 separate IRA accounts with each of the 3 children as beneficiaries if that calms your mind. It would make the RMD's a little bit tricky, but you get the idea.

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Re: Inherited IRA: Using it for kids college

Post by aristotelian » Fri Jun 15, 2018 5:26 pm

llessac15 wrote:
Fri Jun 15, 2018 3:16 pm
Thanks again for all the responses. My wife doesn’t have any care about the money at all. She asked me to just do whatever I think is best with the money. I need to sit down and do the math on lump sum now with a three way split into the 529’s for tax free growth, or do the RMD/let it sit and grow route.

As far as earmarking it for college, that’s just how I do things with my finances. It doesn’t usually make a difference financially, but it gives me peace of mind. I have “earmarked” each of our Roths (kids inheritance), our taxable (early retirement), and our 401k (life after 70) for different purposes. It keeps me organized in my head.
It does make a difference if the mental accounting causes you to make a supremely tax inefficient move, like liquidating an Inherited IRA in a lump sum.

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Re: Inherited IRA: Using it for kids college

Post by livesoft » Fri Jun 15, 2018 5:39 pm

aristotelian wrote:
Fri Jun 15, 2018 5:26 pm
It does make a difference if the mental accounting causes you to make a supremely tax inefficient move, like liquidating an Inherited IRA in a lump sum.
Since the OP is in the highest tax bracket, then we can guess they will be in the highest tax bracket for quite some time. If that is true, then liquidating the inherited IRA to put some money into 529 plans may not be a supremely tax-inefficient move.

Indeed, it may even make sense to take the hit and invest tax-efficiently in a taxable account for someone who is in the highest tax bracket now and the foreseeable future. OTOH, if a taxpayer in the highest tax bracket did not have enough other tax-deferred space for bonds, then it might make sense to use this inherited IRA for low-return investments like bond funds.

Then of course, the decision doesn't have to be either-or, but could be a mix of choices and outcomes: do some of this and some of that and some of this other.
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Re: Inherited IRA: Using it for kids college

Post by 47Percent » Fri Jun 15, 2018 5:50 pm

"Since the OP is in the highest tax bracket, then we can guess they will be in the highest tax bracket for quite some time. If that is true, then liquidating the inherited IRA to put some money into 529 plans may not be a supremely tax-inefficient move."

That's not at all true.. (or may be I should phrase it a bit stronger!)

If someone comes to rob your house and take away your possessions, but gives you a choice between taking it all right-away or a couple of years later, which one would choose?

Choose wisely.

Once it is gone, it is gone. In a few years, circumstances can always change.
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livesoft
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Re: Inherited IRA: Using it for kids college

Post by livesoft » Fri Jun 15, 2018 5:52 pm

^But then again, the choices made are not going to matter that much for very high income families with first-world problems.
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Re: Inherited IRA: Using it for kids college

Post by celia » Fri Jun 15, 2018 7:27 pm

livesoft wrote:
Fri Jun 15, 2018 5:39 pm
Since the OP is in the highest tax bracket, then we can guess they will be in the highest tax bracket for quite some time. If that is true, then liquidating the inherited IRA to put some money into 529 plans may not be a supremely tax-inefficient move.

Indeed, it may even make sense to take the hit and invest tax-efficiently in a taxable account for someone who is in the highest tax bracket now and the foreseeable future. OTOH, if a taxpayer in the highest tax bracket did not have enough other tax-deferred space for bonds, then it might make sense to use this inherited IRA for low-return investments like bond funds.
I'd like to expand on the potential tax bracket issue here. I think the OP and DW should look at this over the long term. Yes, everything that follows will be estimates, but that is better than not looking at the extended future at all.

OP should look at DW's current age and the maximum years the RMDs will last. This is the same number as the starting divisor that is used to calculate RMDs and to see that the account must be emptied out in that period of time. The RMDs will not be spread over her lifetime, but across a shorter time period--unless she dies "early". (In that case, her beneficiary will have to continue RMDs at the same withdrawal rate.)

For example, if she is 40 when the RMDs start, look at Table I in IRS Pub 590b (about 3/4 of the way down the page) and you will see that her divisor is 43.6. For ease of discussion and understanding, let's call this 43. The RMDs are designed to empty out the account for her in 43 years. So the first year, she must remove at least 1/43, the next year 1/42, the next year 1/41, ... the next to last year 1/2, and in 43 years, she will remove 1/1 (or all of it). Of course she can withdraw more during any year or empty the account before then.

During this time the account will keep growing as long as the RMD is less than the growth for the year. 1/43 is 2.3% so you can see that growth is likely at the start. If your average growth in your accounts is 6%, let's say, your RMD won't hit that withdrawal rate until there are 16 or 17 years of withdrawals left. If your average growth in your accounts is more than 6%, your RMD won't hit that withdrawal rate until even later.

OP, then you can make a "timeline" (in Excel) showing the age of each person in your immediate family each year, then mark the timeline to estimate when you and DW will stop working, when the kids will be in their college years, and where the Inherited IRA RMDs will fall across these years. Then, to make it easy, estimate your incomes in each year in today's dollars but grow the IRA over time. (This will take care of inflation increases as the tax brackets historically are adjusted each year for inflation.) Don't forget to look ahead to your and your wife's age 70 income, if you will defer SS until then. If you are tax-deferring the max you can each year, you may need room for Roth conversions in the years you are retired but not yet age 70. Mark those years as Roth conversion years. Mark the years before the kids reach college as Inherited IRA withdrawal years. You will probably get the maximum tax bracket benefit by leveling your incomes across all the years.

At least, this will give you a different way of looking at things.

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Re: Inherited IRA: Using it for kids college

Post by aristotelian » Fri Jun 15, 2018 8:09 pm

livesoft wrote:
Fri Jun 15, 2018 5:39 pm
aristotelian wrote:
Fri Jun 15, 2018 5:26 pm
It does make a difference if the mental accounting causes you to make a supremely tax inefficient move, like liquidating an Inherited IRA in a lump sum.
Since the OP is in the highest tax bracket, then we can guess they will be in the highest tax bracket for quite some time. If that is true, then liquidating the inherited IRA to put some money into 529 plans may not be a supremely tax-inefficient move.

Indeed, it may even make sense to take the hit and invest tax-efficiently in a taxable account for someone who is in the highest tax bracket now and the foreseeable future. OTOH, if a taxpayer in the highest tax bracket did not have enough other tax-deferred space for bonds, then it might make sense to use this inherited IRA for low-return investments like bond funds.

Then of course, the decision doesn't have to be either-or, but could be a mix of choices and outcomes: do some of this and some of that and some of this other.
He said himself that he thought the lump sum would be disadvantageous due to his current bracket. I can only assume that he is going to have lower taxable income in retirement. His tax bracket isn't getting any higher, that is for sure.

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Re: Inherited IRA: Using it for kids college

Post by celia » Fri Jun 15, 2018 8:35 pm

aristotelian wrote:
Fri Jun 15, 2018 8:09 pm
He said himself that he thought the lump sum would be disadvantageous due to his current bracket. I can only assume that he is going to have lower taxable income in retirement. His tax bracket isn't getting any higher, that is for sure.
Not true. We are currently at historically low tax brackets. They will even revert to last year's brackets in 2026 unless Congress votes before then to make them permanent.

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Re: Inherited IRA: Using it for kids college

Post by AlwaysWannaLearn » Fri Jun 15, 2018 9:42 pm

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Re: Inherited IRA: Using it for kids college

Post by llessac15 » Fri Jun 15, 2018 10:07 pm

OP here. After maxing out my 401k and doing my backdoor Roth’s within the first couple months, I usually end up with a substantially larger amount going into my taxable account each year. In retirement, I don’t plan on having any type of debt and most of my withdrawals will be from a taxable account. Without debt, my expenses will be 50% lower, and I will only be paying long term capital gains rates on my withdrawals from the taxable account. With those two factors in play, my income tax bracket should be a good bit lower than my current one (at least until my 401k RMD’s set in). I’m only 38 now and plan to retire at 50. I will have 20 years until RMD’s.

I think what one comment mentioned above rings very true. We are all debating first world problems here.

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Re: Inherited IRA: Using it for kids college

Post by Ben Mathew » Fri Jun 15, 2018 10:31 pm

llessac15 wrote:
Thu Jun 14, 2018 10:35 pm
My wife is inheriting a low 6-figure IRA from her recently deceased father. From what I understand, it is best just to leave it alone and receive RMD’s from it for now. I was hoping to use it to invest for my three very young kids college tuition.
A lot depends on if you're maxed out on retirement accounts (or will be in the future) and wish to shield more. If you are maxed out, then leaving the money in the inherited IRA allows you to shield more. If you are not maxed out, consider taking the money out and funding your own retirement accounts with it. A dollar in your own IRA is generally better than a dollar in an inherited IRA. But if you are set on using the money to pay for college instead, "moving" money to a 529 (by withdrawing from the IRA, paying the tax, and moving the post-tax money to a 529 account) is fine, though not necessary beyond the RMD.
llessac15 wrote:
Thu Jun 14, 2018 10:35 pm
I am in the highest tax bracket so I don’t see the lump sum option as a good one given the enormous tax hit I would take.
If you're in the highest tax bracket now and expect to be in the future, the lump sum becomes more attractive, not less. If you were in a lower bracket, you'd want to spread the distributions out over time so you don't get pushed into a higher bracket. But now you have to pay the top tax rate any way. If you think the top tax rates will rise in the future, that would be a reason to take a lump sum distribution (you can pay your tax from the distribution).

But there are still reasons you might want to spread out the distribution. If the distribution is going to fund your own retirement accounts, you'd want to spread it out over time to match up with what you can contribute to your own retirement accounts in a given year. And if the money is going to 529s, you might want to spread it out over a few years to stay under the annual federal gift tax exclusion.

EDIT: Just saw your update
llessac15 wrote:
Fri Jun 15, 2018 10:07 pm
OP here. After maxing out my 401k and doing my backdoor Roth’s within the first couple months, I usually end up with a substantially larger amount going into my taxable account each year. In retirement, I don’t plan on having any type of debt and most of my withdrawals will be from a taxable account. Without debt, my expenses will be 50% lower, and I will only be paying long term capital gains rates on my withdrawals from the taxable account. With those two factors in play, my income tax bracket should be a good bit lower than my current one (at least until my 401k RMD’s set in). I’m only 38 now and plan to retire at 50. I will have 20 years until RMD’s.
Under these circumstances, you should certainly leave the money in the inherited IRA and stretch it out to fund your retirement. The money for your kids' college should come from the taxable account, not the inherited IRA. Why raid a tax-advantaged account when you have a taxable account?

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Re: Inherited IRA: Using it for kids college

Post by celia » Sat Jun 16, 2018 12:26 am

Ben Mathew wrote:
Fri Jun 15, 2018 10:31 pm
The money for your kids' college should come from the taxable account, not the inherited IRA. Why raid a tax-advantaged account when you have a taxable account?
...because you may want to control future RMDs and the tax bracket they are taxed it.

To me, that is primarily the point of this thread.

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Re: Inherited IRA: Using it for kids college

Post by llessac15 » Sat Jun 16, 2018 5:46 am

Ben Mathew wrote:
Fri Jun 15, 2018 10:31 pm
Under these circumstances, you should certainly leave the money in the inherited IRA and stretch it out to fund your retirement. The money for your kids' college should come from the taxable account, not the inherited IRA. Why raid a tax-advantaged account when you have a taxable account?
Thanks Ben Mathew. Your whole post helped me think through some things and gives me better understanding of all this finance stuff, even if the final advice is straight forward. Your book looks interesting. I need to order a copy sometime.

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Re: Inherited IRA: Using it for kids college

Post by llessac15 » Sat Jun 16, 2018 5:54 am

celia wrote:
Sat Jun 16, 2018 12:26 am
Ben Mathew wrote:
Fri Jun 15, 2018 10:31 pm
The money for your kids' college should come from the taxable account, not the inherited IRA. Why raid a tax-advantaged account when you have a taxable account?
...because you may want to control future RMDs and the tax bracket they are taxed it.

To me, that is primarily the point of this thread.
celia, You’re right. It’s more about flexibility to me at this point. Control of when and how I have to withdraw is very appealing to me. Though tax shelter is nice, the tax shelter with an inherited IRA comes with a lot more rules than my other tax sheltered accounts. But, I don’t want to make a completely bonehead move with the money either. Thanks!

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Re: Inherited IRA: Using it for kids college

Post by CyclingDuo » Sat Jun 16, 2018 7:53 am

llessac15 wrote:
Thu Jun 14, 2018 10:35 pm
My wife is inheriting a low 6-figure IRA from her recently deceased father. From what I understand, it is best just to leave it alone and receive RMD’s from it for now. I was hoping to use it to invest for my three very young kids college tuition. The only way I see this happening is either taking the lump sum and placing the after-tax amount in my 529 accounts, or sending the RMD’s to the 529 accounts each year. I am in the highest tax bracket so I don’t see the lump sum option as a good one given the enormous tax hit I would take.

Any thoughts or recommendations?
Keep the IRA BDA where it is, and take the required RMD's to mitigate your current taxes. You could use the post-tax funds to contribute to the 529's, help fund a vacation, etc... . The lump sum method would be a big hit unless you have a way to defer more of your pre-tax household income in the year(s) you withdrew the lump(s).

The inherited IRA's are a good place to have some asset allocation in investments that would not be so tax efficient in your taxable account.
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Re: Inherited IRA: Using it for kids college

Post by ncbill » Sat Jun 16, 2018 11:13 am

llessac15 wrote:
Fri Jun 15, 2018 10:07 pm
OP here. After maxing out my 401k and doing my backdoor Roth’s within the first couple months, I usually end up with a substantially larger amount going into my taxable account each year. In retirement, I don’t plan on having any type of debt and most of my withdrawals will be from a taxable account. Without debt, my expenses will be 50% lower, and I will only be paying long term capital gains rates on my withdrawals from the taxable account. With those two factors in play, my income tax bracket should be a good bit lower than my current one (at least until my 401k RMD’s set in). I’m only 38 now and plan to retire at 50. I will have 20 years until RMD’s.

I think what one comment mentioned above rings very true. We are all debating first world problems here.
So disclaiming it so it could be split up between the kids to compound over their longer life expectancies wasn't an option?

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Re: Inherited IRA: Using it for kids college

Post by llessac15 » Sat Jun 16, 2018 12:02 pm

ncbill wrote:
Sat Jun 16, 2018 11:13 am
So disclaiming it so it could be split up between the kids to compound over their longer life expectancies wasn't an option?
I’m not sure I know anything about disclaiming the IRA. What do you mean?

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Re: Inherited IRA: Using it for kids college

Post by AlwaysWannaLearn » Sat Jun 16, 2018 12:23 pm

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Re: Inherited IRA: Using it for kids college

Post by celia » Sat Jun 16, 2018 12:56 pm

ncbill wrote:
Sat Jun 16, 2018 11:13 am
llessac15 wrote:
Fri Jun 15, 2018 10:07 pm
OP here. After maxing out my 401k and doing my backdoor Roth’s within the first couple months, I usually end up with a substantially larger amount going into my taxable account each year. In retirement, I don’t plan on having any type of debt and most of my withdrawals will be from a taxable account. Without debt, my expenses will be 50% lower, and I will only be paying long term capital gains rates on my withdrawals from the taxable account. With those two factors in play, my income tax bracket should be a good bit lower than my current one (at least until my 401k RMD’s set in). I’m only 38 now and plan to retire at 50. I will have 20 years until RMD’s.

I think what one comment mentioned above rings very true. We are all debating first world problems here.
So disclaiming it so it could be split up between the kids to compound over their longer life expectancies wasn't an option?
This is dependent on how the original owners stated the beneficiaries. If the wife was a co-beneficiary with her siblings, if she then disclaimed (refused to accept) her share, it would have gone to the other primary beneficiaries (assumedly her siblings). We were in this situation with an IRA that my DH inherited with his siblings. He wanted some of his share to go to our kids, but if he disclaimed any/all of his share, it would go to his siblings.

The easiest way this would have worked was if the deceased had split the account up for each beneficiary while living, then listed one beneficiary as primary and that person's children as secondary. It might also have worked if the original beneficiaries were listed as <child 1> per stirpes, <child 2> per stirpes, <child 3> per stirpes. But if any beneficiary did not have children but wanted their share to go to their spouse, that would be another problem. But after each person takes their share, they can specify their own beneficiaries (who will have to continue RMDs at the same rate the original beneficiary was using).

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Re: Inherited IRA: Using it for kids college

Post by llessac15 » Sat Jun 16, 2018 2:34 pm

The IRA was left to my wife and her sibling. I doubt our children were even mentioned on the beneficiary list. I’ll look into it to be certain.

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