How to handle windfall for taxes and future

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BullHouse_BearMarket
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Joined: Sun Jul 10, 2016 4:19 pm

How to handle windfall for taxes and future

Post by BullHouse_BearMarket »

Hello fellow bogleheads.

I recently posted about the unexpected and devastating loss of my MIL. In that post I was asking advice on handling an inherited IRA. That advice was greatly appreciated and my wife and I followed it.

Now I come seeking advice after we received news on an unexpected windfall from this unfortunate situation. The state pension has decided to pay the value of my MIL pension. This is a significant amount (mid 6 figures) that will double our net worth.

Some brief background and questions:

My wife and I are 31 and 30. We have stable careers and are in the 22% tax bracket. No debt other than mortgage. We have 2 young kids under 2 years old. We will be moving at some point in next 3 years, most likely out of state.

I think we would like to retire by 50-55 if possible. Currently we save Approx. 25-30% of our income.

The pension benefit can be paid in 3 ways.
1. Roll over to IRA
2. Lump sum
3. Annuity

My wife would like to have some portion paid directly to have available as a down payment on new home in a couple years.

So my questions, and maybe I need to provide more info, are:
1. Should we get entire amount in lump sum?
A. If so, are there tax saving options for this or just expect to pay the 37% rate? There is no state or local tax for this money.

2. Should we roll the entire amount, minus the down payment amount, into an IRA?

3. If we roll into IRA, should we backdoor Roth immediately or keep in traditional IRA?
A. If we don't backdoor Roth, are we messing up potential future backdoor options?

I hope I have provided enough information and asked coherent questions. Thank you all in advance.
Gill
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Re: How to handle windfall for taxes and future

Post by Gill »

I think it would be a huge mistake to pay tax on this and not roll it into an IRA where it can accumulate tax deferred the rest of your lives.
Gill
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bloom2708
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Re: How to handle windfall for taxes and future

Post by bloom2708 »

Make sure you understand the tax consequences of each option.

You will have to have cash outside of the IRA to pay the tax on the withdrawals or withdraw extra.

I would roll the full amount to an IRA. Get it invested at a reasonable mix of stocks/bonds and deal with the house down payment down the road.

If you did a Roth Conversion on the whole thing, you would owe tax on the full amount.
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DarthSage
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Re: How to handle windfall for taxes and future

Post by DarthSage »

If you can roll the whole thing over into an IRA, you will have the advantage of tax-free growth for decades. However, I understand wanting some of the money in the Here and Now, when you can benefit from it. I mean, a comfortable retirement is great, but should you live like paupers until you get there?

My suggestion would be to evaluate this in terms of your overall finances. You mentioned that you save 25%+ of your income now, which is fabulous. I would consider putting the inheritance in an IRA and considering retirement close to "set", then saving your other money in post-tax accounts (except for any that's company matched--I hate to pass up free money!). Use the post-tax savings for the new house in a couple years. You could also potentially use any 401k money towards a house by taking a loan against it. Normally, I wouldn't recommend this, but since your retirement is otherwise in great shape, I think you could consider this option. I have no idea where you live, your COL, or how much of a down payment you'd need.

Sorry about the passing of your MIL. Your circumstances are a game-changer, so take your time as you evaluate your options.
Grt2bOutdoors
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Re: How to handle windfall for taxes and future

Post by Grt2bOutdoors »

DarthSage wrote: Thu Mar 05, 2020 6:40 am If you can roll the whole thing over into an IRA, you will have the advantage of tax-free growth for decades. However, I understand wanting some of the money in the Here and Now, when you can benefit from it. I mean, a comfortable retirement is great, but should you live like paupers until you get there?

My suggestion would be to evaluate this in terms of your overall finances. You mentioned that you save 25%+ of your income now, which is fabulous. I would consider putting the inheritance in an IRA and considering retirement close to "set", then saving your other money in post-tax accounts (except for any that's company matched--I hate to pass up free money!). Use the post-tax savings for the new house in a couple years. You could also potentially use any 401k money towards a house by taking a loan against it. Normally, I wouldn't recommend this, but since your retirement is otherwise in great shape, I think you could consider this option.
+1. Roll it all over to the IRA, though with new tax law, am not certain you won’t be required to withdraw the entire amount by the end of 10 years. You may want to read up on the effects of inheritance of retirement accounts from anyone other than your spouse. Sorry for loss of your mother in law.
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Jack FFR1846
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Re: How to handle windfall for taxes and future

Post by Jack FFR1846 »

Roll it over to an IRA. To increase your potential down payment, stop all retirement contributions beyond any matching in 401k/403b. You don't need to save for a while with this big lump added to your IRA.

Why would you take a lump sum and pay 37% federal and whatever state tax when you can delay and take a little at a time if you want at lower rates.
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Flora
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Re: How to handle windfall for taxes and future

Post by Flora »

Effective for deaths occurring after December 31, 2019, funds from an inherited IRA must be fully withdrawn by the beneficiary within 10 years of the decedent's passing.

Roll it to an inherited IRA. There's no need to take a large distribution now for a house downpayment in 2 years.
michaeljc70
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Re: How to handle windfall for taxes and future

Post by michaeljc70 »

Gill wrote: Wed Mar 04, 2020 9:20 pm I think it would be a huge mistake to pay tax on this and not roll it into an IRA where it can accumulate tax deferred the rest of your lives.
Gill
I agree. They can adjust their savings down to save the down payment.
delamer
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Re: How to handle windfall for taxes and future

Post by delamer »

Jack FFR1846 wrote: Thu Mar 05, 2020 7:27 am Roll it over to an IRA. To increase your potential down payment, stop all retirement contributions beyond any matching in 401k/403b. You don't need to save for a while with this big lump added to your IRA.

Why would you take a lump sum and pay 37% federal and whatever state tax when you can delay and take a little at a time if you want at lower rates.
Agreed. But make sure you understand the future withdrawal requirements based on the SECURE Act, as others have noted.

Remember that your wife always can withdraw money from the IRA if needed in 2 years. But she can’t retroactively put money into the IRA in 2 years if she decides she should have rolled over the entire amount.
Topic Author
BullHouse_BearMarket
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Re: How to handle windfall for taxes and future

Post by BullHouse_BearMarket »

Thank you all for the replies and advice. They reaffirm my initial thought of rolling it all into an IRA then adjust how we save to balance pre and post tax retirement savings.

As a side note, my MIL passed away in November 2019. I don't believe this IRA will be subject to the Secure Act, but I could be wrong. I will need to figure out if that is the case. I don't know if this will be treated as an Inherited IRA since it is a pension death benefit. I'll need to figure that out as well.

I'm thinking that since we now have a large amount of retirement savings in pre-tax accounts, we should shift our 401k contributions to Roth 401k and work on contributing to a taxable account as well to cover living expenses if we choose to retire early.

Thoughts?
DarthSage
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Re: How to handle windfall for taxes and future

Post by DarthSage »

BullHouse_BearMarket wrote: Thu Mar 05, 2020 11:37 am Thank you all for the replies and advice. They reaffirm my initial thought of rolling it all into an IRA then adjust how we save to balance pre and post tax retirement savings.

As a side note, my MIL passed away in November 2019. I don't believe this IRA will be subject to the Secure Act, but I could be wrong. I will need to figure out if that is the case. I don't know if this will be treated as an Inherited IRA since it is a pension death benefit. I'll need to figure that out as well.

I'm thinking that since we now have a large amount of retirement savings in pre-tax accounts, we should shift our 401k contributions to Roth 401k and work on contributing to a taxable account as well to cover living expenses if we choose to retire early.

Thoughts?
Yes, I would agree with this. You don't say how much you have/will have in retirement after this, and it's none of my business, but I would consider a couple things:

(1) If your children inherit a Roth, it's subject to the same 10-year rule as a regular IRA (assuming the law doesn't change again--a big assumption, but here we are). But, they would get the money tax-free (assuming...)

(2) It's probably better for your kids to inherit post-tax assets (stocks, etc.) that will be at a stepped-up basis when you pass, thereby giving them a lower tax hit. (again, assuming the law doesn't change...)

I know you're younger than I am (mid-50's), and probably not thinking so much about what you pass on. DH inherited 7 figures a couple years ago, we think a lot about what we're leaving to our kids, and the SECURE Act really changed how we need to look at things. FTR, our plan is to pay for our retirement out of IRAs, leaving as much as possible in post-tax accounts (stocks, etc.) and ROTH accounts.
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sergeant
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Re: How to handle windfall for taxes and future

Post by sergeant »

Jack FFR1846 wrote: Thu Mar 05, 2020 7:27 am Roll it over to an IRA. To increase your potential down payment, stop all retirement contributions beyond any matching in 401k/403b. You don't need to save for a while with this big lump added to your IRA.

Why would you take a lump sum and pay 37% federal and whatever state tax when you can delay and take a little at a time if you want at lower rates.
This is the correct answer!
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ExitStageLeft
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Re: How to handle windfall for taxes and future

Post by ExitStageLeft »

To summarize the comments above, the best plan to accomplish your goals is to:

1) Roll the pension benefit into her IRA.
2) Dial back 401k contributions for a while and instead save those funds in your house downpayment fund.
3) Keep doing that for a couple of years. Meanwhile you have deferred taxes on the inherited pension.
4) In a couple of years look at buying a house.
5) If your downpayment fund isn't large enough, your wife can take out exactly what is needed from her IRA. There will be a 10% tax penalty for early withdrawal, but even that added to your 22% bracket comes out less than the 37% if taken and taxed now.
6) Over the next several years as you get closer to your target for retirement you examine how much you have in tax-deferred and consider Roth conversions as needed to keep future RMDs in check. (Edit to add: also SECURE Act makes traditional IRAs more burdensome for heirs)

Did I miss anything?
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anon_investor
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Re: How to handle windfall for taxes and future

Post by anon_investor »

Gill wrote: Wed Mar 04, 2020 9:20 pm I think it would be a huge mistake to pay tax on this and not roll it into an IRA where it can accumulate tax deferred the rest of your lives.
Gill
+1
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