Inherited 401K - required minimum distributions or lump sum?

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Jimbo11
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Inherited 401K - required minimum distributions or lump sum?

Post by Jimbo11 » Wed Sep 13, 2017 8:36 pm

Hello,

I have done a lot of reading about inherited retirement accounts but I can't find the answer for my specific situation.

1. I inherited a 401K in 2013 at Vanguard.
2. Since inheriting, all I've done is change the account to my name.
3. I've received 3 RMDs so far and have 51 estimated years left. I am 33 years old.
5. My income will increase substantially in the next 5 years such that I will move from the 15% to the 39.6% tax rate in 2022.
6. Taking the money out in a lump sum now will not increase my federal income tax bracket
7. I do have the option to convert to an inherited Roth IRA

What is my best course of action?

Keep the money in the inherited 401K account? Transfer it to an inherited IRA? Transfer it to an inherited IRA and then an inherited Roth IRA? Remove the balance as a lump sum? Something else?

Any advice or experience you can offer would be greatly appreciated.

NancyABQ
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Re: Inherited 401K - required minimum distributions or lump sum?

Post by NancyABQ » Wed Sep 13, 2017 9:21 pm

I am not sure there is enough information there to give really informed advice, but from what you said -- If you really have the option to convert it into an inherited Roth IRA I would seriously look into that.

Paying the taxes for the conversion now now at 15% and having tax free growth and withdrawals (I believe there would still be RMDs, but they wouldn't be taxable) in the future when you are in a higher tax bracket seems pretty good to me.

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Earl Lemongrab
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Re: Inherited 401K - required minimum distributions or lump sum?

Post by Earl Lemongrab » Thu Sep 14, 2017 12:19 pm

There is no option to convert an inherited TIRA to Roth. I believe that you can go directly from 401(k) to Roth IRA, taxes due and RMDs still in effect.
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Re: Inherited 401K - required minimum distributions or lump sum?

Post by hicabob » Thu Sep 14, 2017 12:35 pm

I've read a little about this since I have a good size IRA that may be inherited in the future. The advantage of the RMD approach for an inherited IRA is that you can do a lump sum at any time or just take the minimum and do intelligent tax planning. The financial press seems to love to bash inherited IRA's but they seem pretty good to me assuming the recipient is somewhat financially literate.

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CAsage
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Re: Inherited 401K - required minimum distributions or lump sum?

Post by CAsage » Thu Sep 14, 2017 12:56 pm

None of us have crystal balls on your future income and prospective tax rates. Having said that... if you were my son, I would suggest you take it out at 15% and.... if Ed Slott is right, I would do the Roth IRA. If that is legal/possible, convert to Roth, otherwise cash out and fund your own Roth annually. Not sure about the timing requirements or accuracy....

According to Ed Slott,
"But, can you convert an inherited employer plan such as a 401(k) to an inherited Roth IRA? Yes. In this case, the tax code makes an exception to the non-spouse rollover rule. It allows a non-spouse employer plan beneficiary to do a direct rollover to an inherited IRA account, including an inherited Roth IRA account. The beneficiary must be a designated beneficiary – one who is named on the beneficiary form, not a beneficiary who inherits through the estate. If both the direct rollover and the first RMD are completed by December 31 of the year after the death of the plan participant, then the beneficiary can use the stretch options available in the inherited IRA or inherited Roth IRA account."
Last edited by CAsage on Thu Sep 14, 2017 1:39 pm, edited 1 time in total.
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aristotelian
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Re: Inherited 401K - required minimum distributions or lump sum?

Post by aristotelian » Thu Sep 14, 2017 1:09 pm

If you really can liquidate it at 15% or less, there is no reason not to do that. Taxes generally don't get lower than that. Especially if you expect your income to increase in the future, I would take the lump sum now.

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Watty
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Re: Inherited 401K - required minimum distributions or lump sum?

Post by Watty » Thu Sep 14, 2017 1:19 pm

One option if you are not already maxing out all your other tax advantaged accounts(IRA, ROTH, HSA, 529 etc) is to use the inherited IRA money to indirectly fund those.

For example you could increase your 401k payroll withholdings by $1,000 a month, and then take $1,000 a month out of the inherited IRA for your living expenses. These would cancel each other out on your tax return for most calculations.
Jimbo11 wrote:
Wed Sep 13, 2017 8:36 pm
6. Taking the money out in a lump sum now will not increase my federal income tax bracket
7. I do have the option to convert to an inherited Roth IRA
If the inherited IRA is small enough to convert to a Roth and not put you above the 15% federal tax bracket then there is little downside to doing that since you are on a high income career path.

Alan S.
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Re: Inherited 401K - required minimum distributions or lump sum?

Post by Alan S. » Thu Sep 14, 2017 1:28 pm

Probably a good move to request a direct rollover to an inherited Roth IRA. Your 2017 beneficiary RMD must be distributed first and cannot be included in the direct rollover.

You will then have an inherited Roth IRA from which your beneficiary RMDs must continue starting in 2018. Because of the Roth IRA ordering rules, there will be no earnings included in your small annual RMDs, and after 5 years your inherited Roth will be fully qualified. For the first 5 years, you will have to report your RMD on Form 8606 showing your conversion basis on line 24. After 5 years (2022 if you do the direct rollover this year) you will no longer need the 8606 since the inherited Roth will then be qualified. Note that this inherited Roth IRA is totally separate and independent of any Roth IRA you might own.

If you are not maxing out your own retirement accounts, you can also take out more than the RMD and use it to subsidize maxing out your own retirement accounts. Consider a Roth 401k if your current employer offers that option, at least as long as your marginal rate remains low. Later on when your marginal rate spikes, you should be able to max out without tapping the inherited Roth IRA for more than the small annual RMD. Due to your age, the inherited Roth IRA should grow considerably for years since your RMD should be far less than your average annual gains.

Jimbo11
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Re: Inherited 401K - required minimum distributions or lump sum?

Post by Jimbo11 » Fri Sep 15, 2017 3:34 pm

Thank you all very much for your thoughtful comments and suggestions.

cherijoh
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Re: Inherited 401K - required minimum distributions or lump sum?

Post by cherijoh » Fri Sep 15, 2017 4:18 pm

Jimbo11 wrote:
Wed Sep 13, 2017 8:36 pm
Hello,

I have done a lot of reading about inherited retirement accounts but I can't find the answer for my specific situation.

1. I inherited a 401K in 2013 at Vanguard.
2. Since inheriting, all I've done is change the account to my name.
3. I've received 3 RMDs so far and have 51 estimated years left. I am 33 years old.
5. My income will increase substantially in the next 5 years such that I will move from the 15% to the 39.6% tax rate in 2022.
6. Taking the money out in a lump sum now will not increase my federal income tax bracket
7. I do have the option to convert to an inherited Roth IRA

What is my best course of action?

Keep the money in the inherited 401K account? Transfer it to an inherited IRA? Transfer it to an inherited IRA and then an inherited Roth IRA? Remove the balance as a lump sum? Something else?

Any advice or experience you can offer would be greatly appreciated.
Something doesn't make sense to me. Are you saying taking the entire balance of this inherited 401k won't take you above the top of the 15% federal bracket? If so, the 401k balance can not be very large if your income already puts you into the 15% bracket! The top of the 15% bracket is $37,950 in taxable income for single filers and $75,900 in taxable income for MFJ. Are you currently employed or are you still a student?

Also keep in mind the impact of additional income on any capital gains and qualified dividends. People often mistakenly think that if they are paying 0% tax rate on cap gains and dividends that the cap gains/dividends do not count as taxable income. in fact they do.

If you could liquidate the inherited 401k without paying more than 15% federal taxes and you will be in a much higher tax bracket in the future then going to an inherited Roth IRA makes sense to me - provided that you are still allowed to stretch it. (I know there was a proposal to make people who inherit a Roth IRA withdraw the balance within 5 years but I lost track of the status of the bill and don't know if it would apply in this case).

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