Optimizing Withdrawls from Inherited IRAs

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Phaedrus
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Optimizing Withdrawls from Inherited IRAs

Post by Phaedrus »

I am trying to help two (adult) children tax optimize withdrawals from inherited IRAs from their recently deceased parent.

As context: The deceased was entitled to a lump sum from a defined contribution plan that I understand can be rolled over by the children into inherited IRAs. The decedent had not yet reached the age that requires RMDs, such that I understand the children will have 10 years to withdrawal from the inherited IRAs, without any required annual withdrawal amount so long as the inherited IRAs are emptied by 10 years from death. I also understand they cannot convert the inherited IRAs to Roth IRAs.

One child is currently unemployed and has no income. The other has lumpy employment and maybe ~$20k of annual income. Both have no assets, and some student loan debt. Each should receive an inherited IRA of approx $70k, along with monthly pension payments of ~$1k/month going forward.

Balancing simplicity and tax optimization, would it make sense for both children to withdraw each year an amount to keep their income that year within the federal 12% bracket (no more than $41,775 annual income)?

Are there calculators/tools that can help calculate how much of a difference different withdrawal strategies would make? The amounts here are low enough that I imagine the dollar difference is pretty small, but on the other hand, given their asset levels, even small amounts would make a difference to the beneficiaries.

Is there any reason to not withdrawal from the inherited IRAs as quickly as possible but leave it in for close to the full 10-years?

Thanks in advance for any thoughts.
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retired@50
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Re: Optimizing Withdrawls from Inherited IRAs

Post by retired@50 »

Phaedrus wrote: Sat Sep 24, 2022 4:57 pm Balancing simplicity and tax optimization, would it make sense for both children to withdraw each year an amount to keep their income that year within the federal 12% bracket (no more than $41,775 annual income)?
This sounds about right. ^^^ Avoid spikes, and smooth out the taxes over the coming years.
Phaedrus wrote: Sat Sep 24, 2022 4:57 pm Are there calculators/tools that can help calculate how much of a difference different withdrawal strategies would make? The amounts here are low enough that I imagine the dollar difference is pretty small, but on the other hand, given their asset levels, even small amounts would make a difference to the beneficiaries.

Is there any reason to not withdrawal from the inherited IRAs as quickly as possible but leave it in for close to the full 10-years?

Thanks in advance for any thoughts.
Calculator here:https://engaging-data.com/tax-brackets/

If the money is needed for spending, then I'd just withdraw as needed. If their earnings or income go up over the next 10 years due to changes in employment, then delaying withdrawals may end up costing more in income taxes. Plus, the 12% bracket is scheduled to revert to 15% in 2025 or 2026 I think.

Regards,
If liberty means anything at all it means the right to tell people what they do not want to hear. -George Orwell
Topic Author
Phaedrus
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Re: Optimizing Withdrawls from Inherited IRAs

Post by Phaedrus »

retired@50 wrote: Sat Sep 24, 2022 5:05 pm Calculator here:https://engaging-data.com/tax-brackets/
This is excellent; thank you.
Alan S.
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Re: Optimizing Withdrawls from Inherited IRAs

Post by Alan S. »

Actually, a non spouse beneficiary of a qualified plan has the option to do a direct rollover to an inherited Roth IRA in addition to the more usual direct rollover to an inherited TIRA. Of course, such a rollover to an inherited Roth will be taxable, but if there was any non Roth after tax balance in the inherited plan, that portion should definitely be rolled to an inherited Roth in a non taxable direct rollover.

Once any of these funds are rolled to an inherited TIRA, no conversion is allowed.
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Phaedrus
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Re: Optimizing Withdrawls from Inherited IRAs

Post by Phaedrus »

Alan S. wrote: Sat Sep 24, 2022 10:15 pm Actually, a non spouse beneficiary of a qualified plan has the option to do a direct rollover to an inherited Roth IRA in addition to the more usual direct rollover to an inherited TIRA. Of course, such a rollover to an inherited Roth will be taxable, but if there was any non Roth after tax balance in the inherited plan, that portion should definitely be rolled to an inherited Roth in a non taxable direct rollover.

Once any of these funds are rolled to an inherited TIRA, no conversion is allowed.
Thank you, Alan -- this is very helpful and something I had missed. I don't believe there was any after tax balance in the plan. However, I am wondering if it makes sense for them to do two rollovers: a partial rollover into an inherited Roth IRA and a partial rollover into a tIRA. I assume there's no reason they couldn't elect to split up the rollover in such a manner?

Also, do you know if the partial rollover into an inherited Roth IRA would be subject to the 5-year rule on withdrawing principal from conversions without penalty? They may end up needing to just spend the cash in the near term, so I wouldn't want them to rollover a portion into the Roth IRA if it locked them in for 5-years on the principal.
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Phaedrus
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Re: Optimizing Withdrawls from Inherited IRAs

Post by Phaedrus »

Phaedrus wrote: Sat Sep 24, 2022 11:30 pm
Alan S. wrote: Sat Sep 24, 2022 10:15 pm Actually, a non spouse beneficiary of a qualified plan has the option to do a direct rollover to an inherited Roth IRA in addition to the more usual direct rollover to an inherited TIRA. Of course, such a rollover to an inherited Roth will be taxable, but if there was any non Roth after tax balance in the inherited plan, that portion should definitely be rolled to an inherited Roth in a non taxable direct rollover.

Once any of these funds are rolled to an inherited TIRA, no conversion is allowed.
Thank you, Alan -- this is very helpful and something I had missed. I don't believe there was any after tax balance in the plan. However, I am wondering if it makes sense for them to do two rollovers: a partial rollover into an inherited Roth IRA and a partial rollover into a tIRA. I assume there's no reason they couldn't elect to split up the rollover in such a manner?

Also, do you know if the partial rollover into an inherited Roth IRA would be subject to the 5-year rule on withdrawing principal from conversions without penalty? They may end up needing to just spend the cash in the near term, so I wouldn't want them to rollover a portion into the Roth IRA if it locked them in for 5-years on the principal.
Also, it seems like if the other 5-year rule also applies (on having earnings not be taxable) then it may be of limited benefit to do a partial Roth rollover since it would only help to the extent it could avoid taxation on earnings in years 5-10 (after which the roth has to be fully distributed); is that right?
VanGar+Goyle
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Re: Optimizing Withdrawls from Inherited IRAs

Post by VanGar+Goyle »

Phaedrus wrote: Sat Sep 24, 2022 4:57 pm I am trying to help two (adult) children tax optimize withdrawals from inherited IRAs from their recently deceased parent.

As context: The deceased was entitled to a lump sum from a defined contribution plan that I understand can be rolled over by the children into inherited IRAs. The decedent had not yet reached the age that requires RMDs, such that I understand the children will have 10 years to withdrawal from the inherited IRAs, without any required annual withdrawal amount so long as the inherited IRAs are emptied by 10 years from death. I also understand they cannot convert the inherited IRAs to Roth IRAs.

One child is currently unemployed and has no income. The other has lumpy employment and maybe ~$20k of annual income. Both have no assets, and some student loan debt. Each should receive an inherited IRA of approx $70k, along with monthly pension payments of ~$1k/month going forward.

Balancing simplicity and tax optimization, would it make sense for both children to withdraw each year an amount to keep their income that year within the federal 12% bracket (no more than $41,775 annual income)?
You may have to explain a $12,000 annual inherited pension by non-spouses, that is unusual.
Ignoring the $12,000 annual annuity income, one child may be able to withdraw $12,000 standard deduction a year and pay no income tax.
The other may withdraw mostly in the 12% income tax bracket, as you predicted.
Is there any reason to not withdrawal from the inherited IRAs as quickly as possible but leave it in for close to the full 10-years?
In general you want to avoid any 15%, 22% or 25% income tax brackets that waiting 10 years might cause.
Also they might get other income, such as good jobs, so filling early low tax brackets may help.
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retired@50
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Re: Optimizing Withdrawls from Inherited IRAs

Post by retired@50 »

Phaedrus wrote: Sat Sep 24, 2022 5:30 pm
retired@50 wrote: Sat Sep 24, 2022 5:05 pm Calculator here:https://engaging-data.com/tax-brackets/
This is excellent; thank you.
You're welcome. It is a pretty unique tax illustration.

Regards,
If liberty means anything at all it means the right to tell people what they do not want to hear. -George Orwell
Topic Author
Phaedrus
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Joined: Sat Feb 27, 2010 6:31 pm

Re: Optimizing Withdrawls from Inherited IRAs

Post by Phaedrus »

VanGar+Goyle wrote: Sun Sep 25, 2022 12:51 am You may have to explain a $12,000 annual inherited pension by non-spouses, that is unusual.
The decedent was entitled to a monthly pension check. There were several options that the participant was able to elect upon retirement; the one selected was a slightly lower monthly amount but with a 10-year certain period where if the plan participant passed away, the beneficiaries are still entitled to the monthly amount for the remainder of the 10-year period. I’m not sure what’s typical in the pension world.
Alan S.
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Re: Optimizing Withdrawls from Inherited IRAs

Post by Alan S. »

Phaedrus wrote: Sat Sep 24, 2022 11:34 pm
Phaedrus wrote: Sat Sep 24, 2022 11:30 pm
Alan S. wrote: Sat Sep 24, 2022 10:15 pm Actually, a non spouse beneficiary of a qualified plan has the option to do a direct rollover to an inherited Roth IRA in addition to the more usual direct rollover to an inherited TIRA. Of course, such a rollover to an inherited Roth will be taxable, but if there was any non Roth after tax balance in the inherited plan, that portion should definitely be rolled to an inherited Roth in a non taxable direct rollover.

Once any of these funds are rolled to an inherited TIRA, no conversion is allowed.
Thank you, Alan -- this is very helpful and something I had missed. I don't believe there was any after tax balance in the plan. However, I am wondering if it makes sense for them to do two rollovers: a partial rollover into an inherited Roth IRA and a partial rollover into a tIRA. I assume there's no reason they couldn't elect to split up the rollover in such a manner?

Also, do you know if the partial rollover into an inherited Roth IRA would be subject to the 5-year rule on withdrawing principal from conversions without penalty? They may end up needing to just spend the cash in the near term, so I wouldn't want them to rollover a portion into the Roth IRA if it locked them in for 5-years on the principal.
Also, it seems like if the other 5-year rule also applies (on having earnings not be taxable) then it may be of limited benefit to do a partial Roth rollover since it would only help to the extent it could avoid taxation on earnings in years 5-10 (after which the roth has to be fully distributed); is that right?
There is no tax code restriction on splitting up the direct rollover, but the plan administrator might not cooperate. You might inquire about this if you are interested.

An inherited Roth is not affected by any owned Roth IRAs. While the amount of the rollover (principal) is available anytime without tax and would come out first, any gains would be subject to taxes if withdrawn before completing the 5 year holding period. There is no 10% penalty on distributions from an inherited IRA of any kind.

The 10 year rule without any annual RMDs would apply to both the inherited TIRA and inherited Roth IRA. The inherited Roth will be qualified and fully non taxable after 5 years, but holding it until year 10 provides 5 additional years to generate tax free gains.
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