RMD's

[Spork]

Okay tax experts... help me understand RMDs.

For the sake of the exercise, let me set some assumptions and some nice round numbers.
* John has an IRA
* John is 75 and has begun taking RMDs
* John dies in 2016 after taking his 2016 RMD
* Paul inherits a portion of John's IRA
* Paul turns 50 as of June 1, 2017
* Paul's portion of the inherited IRA is 200,000 at the end of 2016.


This is my understanding (and it's just as likely to be wrong as correct... so check me on this!)

* Nothing happens for Paul in 2016.  RMDs were taken, taxes were paid.
* In 2017, Paul looks at the "Single Life Expectancy Table" (https://www.irs.gov/publications/p590b/index.html - appendix B).  He does this in January when he is 49 and ges a life expectancy of 35.1.
* Paul does the math:  200000 / 35.1 and gets $5698.
* Paul takes out $5700 from the inherited IRA.  This will get added in his income tax towards AGI in his 2017 taxes.


Probably dumb questions pertaining to the above:
* Are inherited IRA calculations based on the age at April 1, 2017 like the original magic "70.5" age is done?  Or at end of the tax year?  I.e, is he 49 or is he 50  when he does the calculation?
* Is there anything "magic" about the distributions that triggers taxes?  In other words, if it's all just bundled with wages/interest/etc and that number remains below "standard deductions+exemptions" ... my assumption is that no tax is owed.
* I'm not sure how to state this as a question, but I'm confused by  "Your withdrawals will be included in your taxable income except for any part that was taxed before (your basis)..."  (from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds )
So... Is the basis going to be stepped up to the date of John's death?  Would the basis be "the value of Paul's portion on the date of John's death?"
* Assuming the previous question is that the basis is stepped up... How do you attribute what amount of the RMD is principle and what amount is gain?  There would obviously be a significant amount of time between John's death and the setup of the inherited IRA.  And Paul is a mustacian, so he would have moved it to index funds at Vanguard.  How in the heck would you map a basis of a complicated mass of stocks on the date of John's death into a simple pile of VTSAX on the date of the RMD?

[Spork]

* I'm not sure how to state this as a question, but I'm confused by  "Your withdrawals will be included in your taxable income except for any part that was taxed before (your basis)..."  (from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds )
So... Is the basis going to be stepped up to the date of John's death?  Would the basis be "the value of Paul's portion on the date of John's death?"
* Assuming the previous question is that the basis is stepped up... How do you attribute what amount of the RMD is principle and what amount is gain?  There would obviously be a significant amount of time between John's death and the setup of the inherited IRA.  And Paul is a mustacian, so he would have moved it to index funds at Vanguard.  How in the heck would you map a basis of a complicated mass of stocks on the date of John's death into a simple pile of VTSAX on the date of the RMD?

It's lonely in here... replying to myself with what I've read so far.  (Again: be skeptical that I am correct in any of this.)

So, it appears basis is NOT stepped up on date of death.  And, if I am reading correctly, it appears that John may or may not have a basis.  If he made non-deductible contributions, he will have a basis and (I think??) can withdraw that portion of the IRA tax free.

If I am reading correctly, Paul will have to look at John's 2016 taxes (when they are filed) and see if there is a form 8606 detailing the cost basis.

I am assuming here then that if there is a basis, Paul will multiply that by the portion of the IRA he inherited.  In other words, if he inherited 25% of the IRA, then he would also inherit 25% of the basis detailed on 2016's 8606.

[2Birds1Stone]

I bet you will get a lot more answers/input over at the Bogleheads forum.

[seattlecyclone]

* Nothing happens for Paul in 2016.  RMDs were taken, taxes were paid.

This looks right. The beneficiaries are responsible for taking out the RMD based on the original owner's age if they didn't do it before they died, but since they did you don't need to worry.

* In 2017, Paul looks at the "Single Life Expectancy Table" (https://www.irs.gov/publications/p590b/index.html - appendix B).  He does this in January when he is 49 and ges a life expectancy of 35.1.

This section of the IRS publication seems to indicate you use the age you will be on your birthday during the first year you're required to make distributions. So if he will be turning 50 during 2017, he uses the life expectancy for a 50-year-old, which is 34.2 years.

* Paul does the math:  200000 / 35.1 and gets $5698.
* Paul takes out $5700 from the inherited IRA.  This will get added in his income tax towards AGI in his 2017 taxes.

Use 34.2 instead of 35.1 to get an RMD of $5,848. Otherwise looks right.

Probably dumb questions pertaining to the above:
* Are inherited IRA calculations based on the age at April 1, 2017 like the original magic "70.5" age is done?  Or at end of the tax year?  I.e, is he 49 or is he 50  when he does the calculation?

See above.

* Is there anything "magic" about the distributions that triggers taxes?  In other words, if it's all just bundled with wages/interest/etc and that number remains below "standard deductions+exemptions" ... my assumption is that no tax is owed.

No magic that I know of. Pretty sure you report these distributions on line 15 of Form 1040 (for IRA distributions), and the amount would then be taxed at your regular marginal rate.

* I'm not sure how to state this as a question, but I'm confused by  "Your withdrawals will be included in your taxable income except for any part that was taxed before (your basis)..."  (from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds )
So... Is the basis going to be stepped up to the date of John's death?  Would the basis be "the value of Paul's portion on the date of John's death?"

Looks as though you figured this out already, but "basis" in an IRA is the amount of non-withdrawn after-tax contributions. Any distributions are allocated proportionally between basis and non-basis funds.

Suppose John had made $20k of after-tax contributions over his life, had never withdrawn anything, and the total account value is $200k. He takes out $10k. Since the IRA is 10% basis, $1,000 of this distribution is a non-taxable withdrawal of basis, and the other $9,000 is taxable.

This leaves $19k of basis remaining in the account. Suppose the market pushes the account value back up to $200k before next year's distribution. The basis does not increase here. He makes another $10k distribution. The account is only 9.5% basis at this point, so $950 is a withdrawal of basis and $9,050 is taxable.

You would look at previous Forms 8606 to find how much basis (if any) is in the account. Or you can just assume that the entire amount is taxable and the IRS probably won't bat an eye.

I am assuming here then that if there is a basis, Paul will multiply that by the portion of the IRA he inherited.  In other words, if he inherited 25% of the IRA, then he would also inherit 25% of the basis detailed on 2016's 8606.

Seems reasonable.

[Spork]

Um... Awesome.  I think I got more right answers than I expected to get.

One follow-up:

Life expectancy is only calculated once, right?  In other words, once you've established 34.2 as your life expectancy in 2017 -- you just use 33.2 in 2018, correct?  (You don't return to the table and re-establish life expectancy every year.)

[seattlecyclone]

Life expectancy is only calculated once, right?  In other words, once you've established 34.2 as your life expectancy in 2017 -- you just use 33.2 in 2018, correct?  (You don't return to the table and re-establish life expectancy every year.)

Yes, if you're a non-spouse beneficiary that's what this part of the publication says. Note that different rules apply to the original account holder and surviving spouses: they look up their life expectancy every year in the appropriate table.

[Frankies Girl]

I never bothered to run the numbers out as far as that on my own inherited IRA. But I've always been in the 15% or lower taxable so the distribution was never enough to trigger much in taxes in my case.

I pretty much just set up an auto distribution, have the financial group (Fido) withhold a % for federal taxes (which may be eliminated since I received all of it back on this last year's taxes) and they take care of the calculations, reporting and tax implications. I do nothing but direct the money where I want it to go.

Should I have been doing all of this?

[seattlecyclone]

"All of this" is basically just how you would calculate for yourself how much the RMD is. If you trust that Fidelity is doing it correctly (which they probably are), then you just report the distribution as income on your tax return and call it good.

[Spork]

I never bothered to run the numbers out as far as that on my own inherited IRA. But I've always been in the 15% or lower taxable so the distribution was never enough to trigger much in taxes in my case.

Depending on the size of the IRA... it may very well be likely to trigger taxes eventually.  I ran a spreadsheet on mine... as that divisor creeps down, the distribution starts going up pretty fast.

I have my own traditional IRAs that will be kicking in around the same time...  I need to really crunch some numbers.  My goal was to keep AGI low (for ACA compatibility).  But it may actually make more sense to do Roth conversions on my personal IRAs in the near term and pay more for insurance.

[DavidAnnArbor]

My goal was to keep AGI low (for ACA compatibility).  But it may actually make more sense to do Roth conversions on my personal IRAs in the near term and pay more for insurance.

Yes I also try to keep AGI low as well for the subsidy benefit. I figure I can do those conversions into Roth when I'm 65 and on Medicare, and no longer using ACA health insurance.

[seattlecyclone]

Yeah, there are definitely a lot of variables we all have to consider. For me personally I'll probably aim for just shy of 200% of the federal poverty level for as long as possible to get the Obamacare cost sharing subsidies. The 150% level would be nice, but that will probably push too much of the traditional retirement account conversions/withdrawals out into older age.

[DavidAnnArbor]

Really good blog Seattlecyclone

[Frankies Girl]

I never bothered to run the numbers out as far as that on my own inherited IRA. But I've always been in the 15% or lower taxable so the distribution was never enough to trigger much in taxes in my case.

Depending on the size of the IRA... it may very well be likely to trigger taxes eventually.  I ran a spreadsheet on mine... as that divisor creeps down, the distribution starts going up pretty fast.

I have my own traditional IRAs that will be kicking in around the same time...  I need to really crunch some numbers.  My goal was to keep AGI low (for ACA compatibility).  But it may actually make more sense to do Roth conversions on my personal IRAs in the near term and pay more for insurance.

Ahh. That makes sense. Dammit. It is getting to be a pretty respectable amount and climbing despite me taking distributions, and doing some very rough math, it looks like I will be paying taxes well before I even start my own IRA distributions. Sigh.

I'll have to look into the Roth conversions on my traditional IRAs too. And figure out if I should be doing them now and forgo the ACA subsidy in the short term.

I know you were asking for yourself, but this definitely wasn't something I'd really thought about, so thank you!

[Spork]

I never bothered to run the numbers out as far as that on my own inherited IRA. But I've always been in the 15% or lower taxable so the distribution was never enough to trigger much in taxes in my case.

Depending on the size of the IRA... it may very well be likely to trigger taxes eventually.  I ran a spreadsheet on mine... as that divisor creeps down, the distribution starts going up pretty fast.

I have my own traditional IRAs that will be kicking in around the same time...  I need to really crunch some numbers.  My goal was to keep AGI low (for ACA compatibility).  But it may actually make more sense to do Roth conversions on my personal IRAs in the near term and pay more for insurance.

Ahh. That makes sense. Dammit. It is getting to be a pretty respectable amount and climbing despite me taking distributions, and doing some very rough math, it looks like I will be paying taxes well before I even start my own IRA distributions. Sigh.

I'll have to look into the Roth conversions on my traditional IRAs too. And figure out if I should be doing them now and forgo the ACA subsidy in the short term.

I know you were asking for yourself, but this definitely wasn't something I'd really thought about, so thank you!

I am still trying to wrap my head around the numbers... so if you figure out a really good method to determine if/when/how much to convert, please share.

There are a lot of variables here to predict:
* return on IRA
* standard deduction, personal exemptions in future
* allowed amount to contribute to HSA
* cost of insurance
* amount of subsidy / FPL
* inflation
* tax rates

[seattlecyclone]

There are a lot of variables here to predict:
* return on IRA
* standard deduction, personal exemptions in future
* allowed amount to contribute to HSA
* cost of insurance
* amount of subsidy / FPL
* inflation
* tax brackets rates

I tend to ignore inflation when I do projections, because the bolded items are all indexed to inflation. Using constant dollars takes a lot of the complexity out of things.

In general, I think one out of two strategies will turn out to be optimal.
1) Try to keep your income (in current dollars) as even as possible for the rest of your life.
2) Keep your income at one level until turning 65, then bump it up a notch if necessary once you're on Medicare and don't need to worry about Obamacare subsidies anymore.

Either option could easily involve taking larger IRA distributions than required early on so that the required distributions later on don't become too huge.

I'd probably be more concerned about the inherited IRA RMD than the personal IRA.

For a personal IRA, the RMD starts out at 3.6% at age 70, gets to 5% at age 79, and doesn't pass 10% until age 93 using the current life expectancy table. This seems pretty manageable.

The inherited RMD percentages can get out of hand much sooner. Suppose you inherit at age 40. Your first year RMD is based on a life expectancy of 43.6, so 2.3%. Contrary to personal IRAs, you don't look up your current life expectancy again every year, you just subtract 1 from the amount you used the previous year. Based on this, the RMD passes 5% at age 64, 10% at age 74, 20% at age 79, and 100% at age 84. Might want to plan to draw down most of it before your 70s so that those high percentages apply to a relatively small total amount.

[Frankies Girl]

I found this nifty calculator regarding Roth conversions up on Fido's site:  https://calcsuite.fidelity.com/rothconveval/app/launchPage.htm

I am also using TurboTax's Taxcaster (https://turbotax.intuit.com/tax-tools/calculators/taxcaster/) to estimate AGI and "in play" taxable events.



So this is my situation anyway:

You're not allowed to do a Roth conversion out of the inherited IRA, so I could take a distribution, then use the funds to make an actual Roth contribution if I was trying to shuttle what money I could back into a tax sheltered account ($5,500/year per me and spouse). BUT I'd still be unable to do this if I didn't have actual earned income for the year (which after this year, we won't - I'm FIREd as of 2015 and the husband just stopped working in April 2016). So sort of crappy for me that this path isn't an option, but I'm not planning on earning a paycheck again if I can help it. ;)

I could start doing Roth conversions on my personal rollover IRA, but it's about half the size of my inherited IRA, and I do agree with seattlecyclone's assessment that the inherited IRA might need more attention since it is required to take distributions now, and is rather large.

So I'm left with looking at taking inherited IRA distributions as a possible main source of living expenses, in addition to my taxable account's dividends (since they're going to consider them in my AGI anyway might as well use them) and avoiding the need for any long term cap gains from my taxable.

I can pull 20k from my inherited IRA without it triggering any taxes whatsoever it looks like (married filing jointly, will be in the 10-15% bracket depending), but our goal expense range is ~35K/year, so I bump that up to 25K, and I owe a minimum of just under $500 for federal taxes, and flesh out the rest of our living expenses using the dividends from my taxable account (additional 10k). Pulling around $25K out of the inherited IRA means I've satisfied the RMD, and reduced the growth enough so that it might just hold steady instead of continuing to grow, but my advancing age will keep pushing the RMD up incrementally each year and still may mean higher taxes in the not too distant future.

The only issue for the present is keeping the AGI lower than $45K so we still keep our subsidy for our silver level healthcare, but there will still be taxes owed even at that income level, and the bill will eventually grow as I age up even if the inherited IRA amount remains constant.

Seems like a catch 22 situation. Granted, a great problem to have... "you have too much money to avoid paying taxes - either a smaller bit now and each year until end of life, or nothing now and a big tax hit that kicks in later in life."

Must think about all of this and do more reading. But absolutely would love any further insight from any that care to contribute and hopefully my inept ramblings might help you out a bit. :)




And have to say if this hasn't been mentioned lately - you and seattlecyclone are both awesome and thank you so much for all your help all over this forum!

[Spork]

That is, more or less, my situation as well.  I had conservatively over-saved for my FIRE with no consideration that some day I would receive the IIRA.  I am trying to work up a rough sketch of what I want to do over time and keeping AGI < 300% FPL.  I'm considering moving that target to just under 400% FPL, but have not really run the numbers yet.

There is, of course, a bit of a domino effect for me.  Pulling extra from the IIRA means I will have extra money I will likely fold into taxable accounts.  This will boost dividends, which will again boost AGI.

Much of this is very much conjecture for me.  Nothing kicks in for me until the 2017 tax year, and 2016 has a lot of unknowns in it still as far as taxable income.

But, there are a lot of worse problems I could have.  It's easy for me to lose focus and worry about tax/insurance costs, when in reality it is not likely to be a real issue.  But it's the aspberger's cheapskate in me.  I over focus on costs of everything.

[ender]

Wow, I've never thought about the implications of RMDs in inherited IRAs before on tax/income planning.

By the time I end up with that as a potential factor (hopefully many years from now!) I also hope to be comfortably retired, so for me it might end up being a wash and more of an optimization than anything else.

[DavidAnnArbor]

I really screwed myself when I invested in taxable accounts from age 29-40, now I'm getting so much dividend income (that's reinvested) that makes the AGI go up. I never really understood then how this would come to bite me. And now with the ACA subsidies hinging on MAGI, it's a challenge to really max out the best I can on solo 401K, 457, HSA, etc. The question as to when I can logically rollover into Roth is a difficult issue. There are so many variables to consider.

[Spork]

I really screwed myself when I invested in taxable accounts from age 29-40, now I'm getting so much dividend income (that's reinvested) that makes the AGI go up. I never really understood then how this would come to bite me. And now with the ACA subsidies hinging on MAGI, it's a challenge to really max out the best I can on solo 401K, 457, HSA, etc. The question as to when I can logically rollover into Roth is a difficult issue. There are so many variables to consider.

First off: This is a great mistake to have made. 

Secondly... I thought the same thing... until I started looking at RMDs.  Had I put more into tax deferred accounts, that would just mean larger RMDs and/or more money that had to be converted into Roths (which also drives up AGI).   

[NathanP]

I really screwed myself when I invested in taxable accounts from age 29-40, now I'm getting so much dividend income (that's reinvested) that makes the AGI go up. I never really understood then how this would come to bite me. And now with the ACA subsidies hinging on MAGI, it's a challenge to really max out the best I can on solo 401K, 457, HSA, etc. The question as to when I can logically rollover into Roth is a difficult issue. There are so many variables to consider.

First off: This is a great mistake to have made. 

Secondly... I thought the same thing... until I started looking at RMDs.  Had I put more into tax deferred accounts, that would just mean larger RMDs and/or more money that had to be converted into Roths (which also drives up AGI).   

I think the difference for early retirees is that taxable accounts raise your AGI in your pre-Medicare years. So, you both pay higher taxes, and lose more of the ACA subsidy (double hit). Loading up your tax deferred accounts can push your AGI up, but only at the age of 70+ when you must begin your RMDs. At this point, you no longer care about the ACA subsidy, and suffer only the impact of higher taxes.

[Spork]

I really screwed myself when I invested in taxable accounts from age 29-40, now I'm getting so much dividend income (that's reinvested) that makes the AGI go up. I never really understood then how this would come to bite me. And now with the ACA subsidies hinging on MAGI, it's a challenge to really max out the best I can on solo 401K, 457, HSA, etc. The question as to when I can logically rollover into Roth is a difficult issue. There are so many variables to consider.

First off: This is a great mistake to have made. 

Secondly... I thought the same thing... until I started looking at RMDs.  Had I put more into tax deferred accounts, that would just mean larger RMDs and/or more money that had to be converted into Roths (which also drives up AGI).   

I think the difference for early retirees is that taxable accounts raise your AGI in your pre-Medicare years. So, you both pay higher taxes, and lose more of the ACA subsidy (double hit). Loading up your tax deferred accounts can push your AGI up, but only at the age of 70+ when you must begin your RMDs. At this point, you no longer care about the ACA subsidy, and suffer only the impact of higher taxes.

If you go back to the example at the top:  I'm (mostly) speaking about inherited IRAs... which are likely to have RMDs NOW.   And while they are lowish now... if I don't start clearing that out, the RMDs are going to be pretty high... right about the same time my traditional RMDs kick in. 

Now... doing the math on the values of both the inherited IRA and my traditional IRA with compounding interest... about the time I hit 70.5, the value of the two of these is going to be pretty enormous.  The RMDs are going to trigger pretty significant taxes.

So... it looks like a delicate balance between taxable and tax deferred.
The taxable account really hits on AGI/subsidies, but not so much on actual taxes.  Being married/filing jointly the rate for qualified dividends is 0% for up to $75k of dividends.  And the rate is 15% on amounts over that.  (Yes it does go up to 20%... but I have to have $467k in yearly qualified dividends for that.  If that happens, I'll light my cigars with $100 bills and just have my accountant take care of the pesky taxes.)
The tax deferred account hits hard later in life on ordinary income tax.  With double RMDs (traditional and inherited) ... it's possible almost unavoidable that I will be having income that is 2-4x more than I have ever made.

So in this odd situation... it may actually be preferable to take less subsidy (possibly even no subsidy) and transition some of this money to Roth and/or taxable.  Figuring out the actual optimal amount to transition here... is more than a little bit difficult.... and likely to be foiled by someone changing laws over the next 40 years.

And as I mentioned: these "terrible" problems are really not so terrible.  It just mostly means I over saved for retirement.

edit: fix some poor wording

[Rubic]

So... it looks like a delicate balance between taxable and tax deferred.
The taxable really hits on AGI/subsidies, but not so much on taxable.  Being married/filing jointly the rate for qualified dividends is 0% for up to $75k of dividends.  And the rate is 15% on amounts over that.
The tax deferred hits hard later in life on ordinary income tax.  With double RMDs (traditional and inherited) ... it's possible almost unavoidable that I will be having income that is 2-4x more than I have ever made.

I'm in a similar first world, high-class, mustachian predicament, though predicament perhaps overstates the case.

Years and years ago I wasn't even worried about RMD's because, hey, how bad can it be if my returns are so awesome that I'll be pushed into a higher tax bracket at age 70?  However, I recently estimated my RMDs and added in SS income that I'll probably begin drawing at age 70.  I realized that if I don't begin some Roth conversions soon, I'll be paying at least $7K extra in taxes at 70 and that number will increase each year.

As OP states, it's a high quality problem to have.