Author Topic: My Inherited IRA puzzle  (Read 5018 times)

Dividend Bro

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My Inherited IRA puzzle
« on: March 29, 2015, 02:16:22 AM »
Hello fellow Mustachians!

By way of introduction, I am Dividend Bro. I have recently stumbled upon the FI community within the past 6 months or so, but I've always been a saver and investor. I would say I've saved more than the average person, but less than a hardcore FI person. Figure maybe 20-25%ish of my income in the few working years I've had so far. I value travel and fun trips with friends highly so I have put emphasis on that for sure.

I am in my late twenties, single, completely debt free, have no car payment, blah blah blah. Rent is my biggest expense but I enjoy where I'm living and it's reasonable. I [unfortunately] took control of an Inherited IRA last year, and it has obviously made my financial situation both easier and more complex at the same time. Thus, I am hoping you guys can put your brains together and help me solve this puzzle .

I will try to keep the detail to a digestible minimum, but here goes.

My end goal is to be semi-retired or, if things go well, fully retired with a family by 40 - 45. I don't think I would mind working somewhere or doing something "fun" (read: half my salary) if I had enough passive income to supplement it. If things go well and I can make some smart RE moves or something, great. For now, let's assume my salary will allow me to save at least $12-13k a year to start, with plans on doubling that rate in the next few years hopefully.

Here's my financial situation:

Taxable - $33k in mostly blue chips/dividend growers. Looking to balance this out with Index funds in the future.
Pre-tax 401k - $37k, indexed
Roth 401k - $20k, mostly indexed, some cash
Inheritance - $340k, mostly in blue chips/aristocrats

I will be using the RMD + dividend income to supplement one of my parent's retirement until they are 70, when they can receive maximum survivors benefits. At that point, I will be 40 and able to use the RMD's as I wish, with the exception of having to pay property taxes.

Bottom line is, using a very conservative estimate, when I am 40, I will have about $500k in an inherited IRA spitting out about $12k in an RMD pre-tax, with bigger RMD's each year. Under the same assumptions, I will have a $1 million+ portfolio paying me somewhere around $60k + in RMDs by the time I'm retirement age.

Problem number 1 with this situation is that I have no clue what the market is going to be like when I'm in my 40s and the RMDs can fluctuate a decent amount until then and also the entire time I'm holding it frankly.

My main conundrum, however, is where I should be putting my money. Assuming I am pretty much set for retirement, should I be putting all my money (including withdrawing from the Roth) into a taxable account? Should I be socking away money pre-tax in the 401k to offset my RMDs?

I have done a fair amount of searching on Inherited IRAs and it seems like people either have millions and it doesn't really matter what they do, or they don't have enough to keep stashed away for retirement, using it towards a house or family expenses instead. I seem to be stuck in that "sweet spot" where I don't need to touch the principal, but it's not enough right now to reach FI. It is enough for a "normal retirement" however. Just trying to figure out how to best use this situation to my advantage.

Did I lose you guys?








« Last Edit: March 30, 2015, 11:00:27 AM by Dividend Bro »

Argyle

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Re: My Inherited IRA puzzle
« Reply #1 on: March 29, 2015, 02:19:46 AM »
I'm in a similar situation.  My solution may be rather primitive.  While I was in a low tax bracket, I put the money in a Roth IRA.  When I got into a higher tax bracket, I put it into a traditional IRA.  Does that answer the question?

Dividend Bro

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Re: My Inherited IRA puzzle
« Reply #2 on: March 29, 2015, 02:45:32 AM »
Thanks Argyle. I would expect my tax bracket to be at 25% for at least the next decade, eventually inching up to 28%, unless I find side income to get me there sooner. Even if so, would that make much of a difference in the grand scheme of things?

NICE!

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Re: My Inherited IRA puzzle
« Reply #3 on: March 29, 2015, 05:58:02 AM »
I'm sorry for your loss but happy that the loved one left behind money instead of bills. You're very fortunate.

I second the Roth IRA input, unless you want to check out the Mad FIentist's method. I think it works well if you expect to have much lower income in the future, but I have no idea how your RMDs are characterized when it comes to taxes:

http://www.madfientist.com/traditional-ira-vs-roth-ira/

Also, since you're still young in the game and the amount in your accounts is relatively low, I recommend you consider Betterment (or another similarly-priced option). I would do it myself if I didn't have to untangle a bunch of investments at Vanguard. Check out MMMs article on the subject:

http://www.mrmoneymustache.com/2014/11/04/why-i-put-my-last-100000-into-betterment/
« Last Edit: March 29, 2015, 06:32:50 AM by NICE! »

Dividend Bro

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Re: My Inherited IRA puzzle
« Reply #4 on: March 29, 2015, 08:47:50 AM »
Thanks NICE! Are both of you suggesting a Roth IRA because I can withdraw the contributed principal at any time? Also, after I max it out and take the company match, then what do you think is the best course of action? I know it's kind of hard to say given the situation.

NICE!

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Re: My Inherited IRA puzzle
« Reply #5 on: March 29, 2015, 09:03:08 AM »
Yeah, that's one of the greatest bennies of a Roth for early retirees. I only say to consider the Mad FIentist approach as well since it involves you eventually getting the money to a Roth from a Traditional. I'm personally not doing it because DW plans to work for basically forever and there's a decent possibility that I get a pension, meaning consistent income.

Dividend Bro

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Re: My Inherited IRA puzzle
« Reply #6 on: March 29, 2015, 02:08:05 PM »
Ok, I think it's starting to all make sense now.

Instead of treating the Inherited IRA as a safety net for "normal retirement" and focusing on income in the near term, it's better to use the tax advantages available to me to accumulate wealth in my retirement accounts. This way I can better utilize the inherited account when it comes time to FIRE or semi-FIRE. In this way, when the time comes I could potentially use a larger withdrawal % on the inherited account if need be, knowing that  I have a solid amount of money in the bank for when I hit 59 1/2.

Thus, I'm thinking my strategy should be:

- Use pre-tax 401(k) contributions to for tax advantages/offsetting the tax on RMD
- Contribute to Roth IRA and let grow for either 1) withdrawal of contributions for a large expense or to supplement income, 2) Have a tax free nest egg
- Invest the rest in a taxable brokerage account to accumulate a solid growth + income stream that can be tapped into at any point.

Is this a more reasonable way to look at things?

Another Reader

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Re: My Inherited IRA puzzle
« Reply #7 on: March 29, 2015, 04:23:55 PM »
If you are in your late 20's, the RMD's are a very small percentage of the $340k.  In your shoes, I would invest the money in the inherited IRA with the idea that there is enough cash available to pay out the RMD's at any given time for at least the following year and the rest of it as you would for any money you will not need for somewhere between 12 to 20 years.

The RMD's today are not significant in your tax calculations.  To minimize current taxes, I would max out the 401k, with the idea of rolling it over into a traditional IRA when you leave your employer.  Once your income drops at RE, you can start converting the traditional IRA to Roth at a rate that depends on your then current tax rate.  You will want to do this before your RMD's start affecting your tax rate significantly.  As someone that inherited an IRA later in life, I can tell you that tax smoothing becomes a chore as you get closer to taking your own RMD's.  It may be helpful to create a spreadsheet that estimates the growth of the inherited IRA and the RMD's and your 401k/IRA and its RMD's if not converted.  Add in some conversion scenarios with your estimates of taxable income to get an idea where it makes sense to convert.

The flexibility of the Roth is helpful.  If you can put enough in there, it's a good tax-free nest egg, as you say.  With a spouse likely to come on board, you can put even more away in that nest egg.  You will have to re-do your spreadsheet when that happens and adjust for your spouse's income.

Dividend Bro

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Re: My Inherited IRA puzzle
« Reply #8 on: March 29, 2015, 07:12:42 PM »
Another Reader,

Thank you for the input! The RMD situation really throws a wrench into things. But yes, I agree, I think heavily contributing pre-tax to the 401k would be very beneficial to my situation.

I have a spreadsheet now that projects out the growth, income, RMD and after-tax payout given salary/income assumptions for the inherited IRA. I also started a basic growth assumption of my 401k and Roth, and projected payouts at 59 1/2. I will need to work on creating conversion scenarios as you mentioned.

The time of conversion is tricky, since it's based a bit on luck, timing, and your current situation. But I'm grateful to be able to maximize the gift I was given and not squander it like the majority of inheritances.

Argyle

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Re: My Inherited IRA puzzle
« Reply #9 on: March 29, 2015, 10:31:34 PM »
My thinking on the Roth is: You're in a low tax bracket, so paying the tax on the money now will be better than paying the tax in a higher tax bracket later.  Of course, who knows if you'll be in a higher tax bracket later?  But I'm guessing this is probably the lowest tax bracket you'll be in you won't be in any lower one in the future.

seattlecyclone

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Re: My Inherited IRA puzzle
« Reply #10 on: March 30, 2015, 09:06:41 AM »
I think you should max out your pre-tax retirement accounts. You're in the 25-28% bracket while you're working, and will likely be in a lower bracket during your early retirement. You'll just have to live with the RMDs while you're still working, no getting around that. When you retire, the inherited IRA is a great thing to have because there are no early withdrawal penalties on it. So you can withdraw as much as you want out of there, just paying your regular income tax rate. If you don't think the balance in that account is enough to see you through to 59, you can supplement with a Roth conversion pipeline.

Dividend Bro

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Re: My Inherited IRA puzzle
« Reply #11 on: March 30, 2015, 10:59:35 AM »
Argyle -

You are correct. My RMDs will continue to grow and keep pushing me into higher tax brackets inevitably. Even if I had no other income, I would still find myself in the 25/28% bracket in a few decades. Hopefully by then I will find some creative ways to reduce my taxable income - a family, perhaps? :)

Seattlecyclone - I suppose with some very creative financial engineering, and assuming a family, I could push my rate down for 15% for a period of time, but the RMDs will drive my bracket up again eventually.

Again, there is no telling what could happen in the future, so it's best to plan for multiple scenarios if possible.

 I would be able to match the RMDs dollar-for-dollar in pre-tax 401(k) contributions for at least the next 10 years. This will give me a tax break on the RMDs and drive up my retirement balance.

I should also be able to max out my Roth for the foreseeable future, and will save the rest likely in a taxable account. This is tax-free gravy money should I need it at 59 1/2, or can be converted depending on my situation later in life.

The taxable account will continue to grow slow and steady and should allow me to have enough cash available for some sort of real estate property and short trips. A triple-whammy, if you will.

Thanks all for your input, it is highly valued. Talking through my strategy in this thread has vastly changed the way I am looking at things now.




seattlecyclone

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Re: My Inherited IRA puzzle
« Reply #12 on: March 30, 2015, 12:25:28 PM »
Seattlecyclone - I suppose with some very creative financial engineering, and assuming a family, I could push my rate down for 15% for a period of time, but the RMDs will drive my bracket up again eventually.

How do you figure? With a family (spouse plus one child), the 25% federal tax bracket doesn't begin until your gross income is $99,500. This number is adjusted upward for inflation each year. Plugging your situation into this calculator (assuming you're 30 years old, starting with a $340k account balance, and earning a 6% real return on the money each year), your RMD at age 60 would be only $37k. That's assuming you only take out the RMD each year, leaving the rest of the balance to grow. If you instead take out your full living expenses from the inherited IRA each year after you retire, the account balance will be depleted faster and your RMDs will never rise to this level.

Catbert

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Re: My Inherited IRA puzzle
« Reply #13 on: March 30, 2015, 01:22:17 PM »
Also remember that the RMD is the minimum you have to take out.  You can take out more than that and pay taxes but no penalties.  If/when you have a year with less taxable income then take out more than the RMD.

Also look at this has part of your overall portfolio.  Put your allocation of things taxed as capital gains in your taxable accounts and those taxed as ordinary income into your inherited IRA.  Corporate bonds and dividend paying stock belong in the inherited IRA.  Aggressive stock funds belong in your taxable account. 

Dividend Bro

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Re: My Inherited IRA puzzle
« Reply #14 on: March 30, 2015, 03:06:08 PM »
seattlecyclone -

I still have some work to do on my model. Your RMD calculation is not far off from what I have currently. Right now, I only am looking at single tax rates, but will build one out for with spouse and with spouse + child. How do you come up with the $99,500 figure?

Mary w- Yes it is a balancing act as far as allocation. Currently, I am weighted toward income producing dividend stocks to provide a solid income stream for my situation, but looking to slowly phase out to a more total-return approach as my obligation to provide income starts to dwindle. Fun times.


seattlecyclone

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Re: My Inherited IRA puzzle
« Reply #15 on: March 30, 2015, 03:35:11 PM »
I still have some work to do on my model. Your RMD calculation is not far off from what I have currently. Right now, I only am looking at single tax rates, but will build one out for with spouse and with spouse + child. How do you come up with the $99,500 figure?

The married-filing-jointly 25% tax bracket starts at $74,900 of taxable income. Take that taxable income, add a $12,600 standard deduction, then add a $4,000 personal exemption for each member of the family and you get an adjusted gross income of $99,500 for a three-person family.

If you itemize your deductions or have any deductions that are listed on the front page of your 1040 (HSA contributions, for example), the gross income can be even higher.

Dividend Bro

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Re: My Inherited IRA puzzle
« Reply #16 on: March 30, 2015, 06:51:53 PM »
Thanks for the info seattlecyclone.