Inherited stretch IRA pushing me into a higher tax bracket

[mcluhan]

I inherited a stretch IRA from my dad back in 2014. It wasn’t much money to begin with, but it has grown over the years and now the yearly required minimum distribution is pushing me up into a higher tax bracket. I’m 55 years old, and would ideally like my income to be under $50,000 a year.

I was thinking that I could convert part of the IRA into some sort of annuity, but interest rates are probably too low right now to get a decent return. Another solution would be to withdraw a chunk of money every five years or so and just deal with the costs for that year.

Am I overlooking a simple solution? Any thoughts?

[secondcor521]

Other ideas:

1.  Accept the higher income.  Except in rare circumstances, higher income means higher after-tax cash flows.  If you don't want the cash flows, then you can give the money away after paying the taxes on it.

2.  Shift the investments inside the IRA to hold more conservative investments, like bonds.  Rearrange the rest of your accounts so your overall AA is where you want it.

3.  Start doing QCDs when you're 70.5.

4.  It won't help you, but for others who might see themselves getting into this kind of situation, they can partially or fully disclaim the inheritance in the first place.

[lhamo]

Do you plan to do any charitable giving over the rest of your lifetime?  Not sure if you can divert the RMDs directly, but if not you could offset the IRA income with enough tax deductible donations to get you below your desired threshhold, either directly year by year or through donating bigger chunks to a donor advised fund.

[dandarc]

Do you plan to do any charitable giving over the rest of your lifetime?  Not sure if you can divert the RMDs directly, but if not you could offset the IRA income with enough tax deductible donations to get you below your desired threshhold, either directly year by year or through donating bigger chunks to a donor advised fund.

On this topic, and since we're approaching year-end - for 2021 you can deduct up to 100% of your AGI for cash contributions to qualified charities. So if OP is truly worried about RMDs, there is effectively no limit this year on donating from the inherited IRA to charity, just need to get the withdrawal and contributions done before 12/31/2021.

[seattlecyclone]

Do you plan to do any charitable giving over the rest of your lifetime?  Not sure if you can divert the RMDs directly, but if not you could offset the IRA income with enough tax deductible donations to get you below your desired threshhold, either directly year by year or through donating bigger chunks to a donor advised fund.

On this topic, and since we're approaching year-end - for 2021 you can deduct up to 100% of your AGI for cash contributions to qualified charities. So if OP is truly worried about RMDs, there is effectively no limit this year on donating from the inherited IRA to charity, just need to get the withdrawal and contributions done before 12/31/2021.

You have to be 70½ to make a qualified charitable distribution, unfortunately. You could still claim an itemized deduction, but that wouldn't help with the AGI.

[dandarc]

Do you plan to do any charitable giving over the rest of your lifetime?  Not sure if you can divert the RMDs directly, but if not you could offset the IRA income with enough tax deductible donations to get you below your desired threshhold, either directly year by year or through donating bigger chunks to a donor advised fund.

On this topic, and since we're approaching year-end - for 2021 you can deduct up to 100% of your AGI for cash contributions to qualified charities. So if OP is truly worried about RMDs, there is effectively no limit this year on donating from the inherited IRA to charity, just need to get the withdrawal and contributions done before 12/31/2021.

You have to be 70½ to make a qualified charitable distribution, unfortunately. You could still claim an itemized deduction, but that wouldn't help with the AGI.

Right - not a qualified charitable distribution. They removed the usual 60% of AGI cap on itemized charitable deductions for 2021 like they did last year. And I thought with an inherited IRA, you had to do at least the RMD every year, but you could opt to do more? Maybe I'm wrong there. And I'm assuming this stretch IRA is a traditional IRA because OP says the RMDs are putting them in another tax bracket.

What I was saying is in separate steps, withdraw from the IRA, then donate the money to charity. Withdrawal from the traditional IRA increases AGI, donation backs that out for taxable income if you donate enough to where you're itemizing. Of course everyone's situation is complicated - could be all sorts of other things to take into account with increasing the AGI like this, and you'd be forgoing the standard deduction if you did this.

[dandarc]

And of course, don't take my word for it:
https://www.irs.gov/newsroom/expanded-tax-benefits-help-individuals-and-businesses-give-to-charity-during-2021-deductions-up-to-600-available-for-cash-donations-by-non-itemizers

[mcluhan]

I appreciate all the replies. It doesn’t seem very Mustachian, but the best option is probably just to accept the higher income and pay the taxes. The one other thing I might do is open an HSA account.

[solon]

Could you quit work? Or reduce your hours? Take the RMD and then work just enough to reach $50k?

[chasesfish]

I appreciate all the replies. It doesn’t seem very Mustachian, but the best option is probably just to accept the higher income and pay the taxes. The one other thing I might do is open an HSA account.

Just how much is it pushing you over?   Is it messing with your ACA Tax Credits?

I inherited a small IRA this year and am trying to figure it out.  It's subject to the 10 year rule.   Unfortunately I don't live in a state free of income taxes, we have preferable capital gain taxes but that's about it.   Part of my debate is have a big year then a small year in income, but I'm favoring harvesting gains over other forms of income because it's only costing me around 12% all in between the lost tax credit and the state hit. 

You just have to model it all out.  Personally if I were in a state free of income taxes, taking all of the 22% to 24% tax bracket in a single year is not a terrible thing.

[MustacheAndaHalf]

What I was saying is in separate steps, withdraw from the IRA, then donate the money to charity. Withdrawal from the traditional IRA increases AGI, donation backs that out for taxable income if you donate enough to where you're itemizing. Of course everyone's situation is complicated - could be all sorts of other things to take into account with increasing the AGI like this, and you'd be forgoing the standard deduction if you did this.

The amount matters, too.  Someone donating $5,000 to charity may do their taxes next year and find the $12,550 (single) standard deduction is better.  Someone donating $48,000 will find that worthwhile to itemize.

For those making too much this year, consider donating investments to a donor-advised fund (DAF) instead of cash.  You could donate 200 shares of VTI ($48k) with long-term gains, and never pay the gains.  Then take the $48k cash you would have donated, and buy 200 shares of VTI.  Now you have the $48k deduction, and 200 fresh VTI shares with $0 in gains.

[Car Jack]

We all have to pay taxes on tax deferred accounts eventually.  Remember that your own income is filling up those lower tax brackets first, so your overall tax rate isn't going to be high when all's said and done.  I always look at things that push my own tax rate up as further income.  Even if something were 50%, I think "Hey, I got 50% more than I would have had".  We actually will have an inheritance from my wife's aunt in the coming year.  Both of us might be retiring, so it'll impact us less than it would this year.  Plus both our parents are in their mid and upper 80's so it's likely we'll be inheriting more in the not so distant future.  And I'm in a state where if the estate is one dollar over $1M, it is fully taxed from dollar one.  So the difference between a $999,999 estate and a $1,000,001 estate is $0 in tax or $50k in tax.  I know my mom's estate is in the $1.5M range, so tax will be paid.  My reaction is "shrug, that's fine".

[mcluhan]

Could you quit work? Or reduce your hours? Take the RMD and then work just enough to reach $50k?

I worked part time for a few years and then stopped as the RMD increased. 

[mcluhan]

I appreciate all the replies. It doesn’t seem very Mustachian, but the best option is probably just to accept the higher income and pay the taxes. The one other thing I might do is open an HSA account.

Just how much is it pushing you over?   Is it messing with your ACA Tax Credits?

I inherited a small IRA this year and am trying to figure it out.  It's subject to the 10 year rule.   Unfortunately I don't live in a state free of income taxes, we have preferable capital gain taxes but that's about it.   Part of my debate is have a big year then a small year in income, but I'm favoring harvesting gains over other forms of income because it's only costing me around 12% all in between the lost tax credit and the state hit. 

You just have to model it all out.  Personally if I were in a state free of income taxes, taking all of the 22% to 24% tax bracket in a single year is not a terrible thing.

Schwab dot com has a good calculator for inherited IRA's. You might want to take a look if you haven't already. I think I will play around with the numbers and see if it would be better to just pay the taxes each year (and buy more expensive health insurance) or take a big chunk of money out once every five years and be in a lower tax bracket the other four.

Yes, it's messing with my ACA Tax Credits. Health insurance is really the main thing I'm worried about right now. I guess I'll just get a high deductible plan and fund an HSA.

[blue_green_sparks]

We all have to pay taxes on tax deferred accounts eventually. 

Yeah, I have been calculating our potential taxes with each "phase change" and trying to figure optimal Roth IRA interplay. We are currently coasting with low income, and cheap insurance. Next comes the SS/Pension/Medicare phase. Finally the RMD phase.

[eyesonthehorizon]

I want to say it's Paula Pant's voice I'm remembering saying "don't let the tail wag the dog when it comes to taxes." Taxes are nearly always a fraction of the income you received, meaning you are still receiving more than you're paying. Not sure what else is driving your picture to want to stay under $50k, since various things could create a bigger splash than the taxes alone, like ACA subsidies depending on your family size. But if it's solely about the taxes, if it's all surplus you don't need or care to spend anyway, there are donation remedies to let you direct the usage of the funds. Since giving up a portion from a pretax account was always inevitable you don't have to stress over failing to optimize it; via giving you get some say in who receives it & how it's used.

[DaTrill]

I'm starring down a tax torpedo and not sure which bullet to bite first, pay higher taxes/pay higher ACA premiums now or in the future.  After calculations, which are rarely definitive, I keep coming back to "But what if/when _____ changes?" and most likely going to rotate from low rollover/high subsidy one year and then high rollover/low subsidy the next. 

Has anyone experimented with this strategy?  I read one posted changed plans from year to year but mis-timed when they were sick and needed the care.  Of course, one could plan to use health insurance one year with low income high subsidy Silver and when assumed not to use health care pay high taxes/low subsidy/high deductible, but this does not seem like a wise strategy.