How to minimize taxes on inherited IRA?

[BadAtGolf]

We will be inheriting money n the next few months. It comes from a qualified plan so we’ve been told it needs to go into an inherited IRA. I tried searching the forum but couldn’t figure out how to find “inherited IRA” and not either of the words individually, so i apologize if this has been discussed recently - and I welcome links to those threads.

My understanding is that we have a few options and I’m looking for some clarification/advice, please.

We will be in the top tax bracket this year and next year, so taking the money in a lump sum isn’t a good option right now. The person leaving the money was in her 80s, so I don’t think the life expectancy plan is an option. That leaves the 10 year plan for us, as far as I can tell.

I’m thinking we leave the money in an inherited IRA until our income is lower so we’re not in the top bracket. But, if we took the $12,000 each year and deposited it directly into a tIRA (or deposited an equivalent amount into a 401k), would it basically be a wash, tax wise? We’d be taxed on the withdrawal, but we would offset that with the tIRA or 401k deposit?

What else should we consider with an inherited IRA? Any other ways to minimize tax impact?

 

[Sunset]

I think in most cases taking an inherited IRA out at one time is the worst tax move.

Waiting until your income is low is a good plan, as long as you know you will have low income for a few years to spread out the withdrawals.

The money can be taken out in any amounts as long as its all out by the end of the 10th year.

Money is fungible, so if you contribute $x to an tIRA or 401K it will lower your income, whether you have an inherited IRA or not doesn't really impact if this is a good idea and doesn't make it a good idea on it's own. Since you are in a high tax bracket, why would you NOT be making large 401K contributions already

Sometimes you just have to pay tax and be happy you are getting something.

 

[RetiredHappy]

We will be inheriting money n the next few months. It comes from a qualified plan so we’ve been told it needs to go into an inherited IRA. I tried searching the forum but couldn’t figure out how to find “inherited IRA” and not either of the words individually, so i apologize if this has been discussed recently - and I welcome links to those threads.

My understanding is that we have a few options and I’m looking for some clarification/advice, please.

We will be in the top tax bracket this year and next year, so taking the money in a lump sum isn’t a good option right now. The person leaving the money was in her 80s, so I don’t think the life expectancy plan is an option. That leaves the 10 year plan for us, as far as I can tell.

I’m thinking we leave the money in an inherited IRA until our income is lower so we’re not in the top bracket. But, if we took the $12,000 each year and deposited it directly into a tIRA (or deposited an equivalent amount into a 401k), would it basically be a wash, tax wise? We’d be taxed on the withdrawal, but we would offset that with the tIRA or 401k deposit?

What else should we consider with an inherited IRA? Any other ways to minimize tax impact?

1. Since you have 10 years to deplete the inherited IRA, you should wait until after you drop off from top tax bracket for the next 2 years.
2. You cannot move inherited IRA money into Traditional IRA. The tax man wants to be paid. The money becomes taxable $ once withdrawn from the inherited IRA. Whatever you want to contribute to 401K is a separate event, and needs to be from earned income from employment.

You just have to figure out when to take money out of inherited IRA from year 3 to 10, balancing between duration of tax deferred growth vs. tax bracket. I would take a look at IRA RMD table for ideas... looking at divisors from age 108 to 115.

 

[BadAtGolf]

Thank you. I haven’t had a 401k until this month and all of my excess income was being put into my company, so we’re catching up on retirement accounts now.

I’m probably overthinking it, but wanted to make sure there weren’t any tricks or loopholes I was missing.

I think in most cases taking an inherited IRA out at one time is the worst tax move.

Waiting until your income is low is a good plan, as long as you know you will have low income for a few years to spread out the withdrawals.

The money can be taken out in any amounts as long as its all out by the end of the 10th year.

Money is fungible, so if you contribute $x to an tIRA or 401K it will lower your income, whether you have an inherited IRA or not doesn't really impact if this is a good idea and doesn't make it a good idea on it's own. Since you are in a high tax bracket, why would you NOT be making large 401K contributions already

Sometimes you just have to pay tax and be happy you are getting something.

 

[Sunset]

Do you have your own company, if so you might want to start a new thread and ask about 401K advice since it's new for you.

There are differences based on the type of company you have and if you have employees or not.

 

[Scratchy]

What else should we consider with an inherited IRA? Any other ways to minimize tax impact?

If the beneficiary designation on the IRA was per stirpes, consider disclaiming. IRA would go to your children. They would still be subject to the ten year rule (even if they are minors they would not have the more favorable EDB status as they are not the children of the owner) but depending on their ages and incomes this would likely save taxes.

Of course, consult with an attorney or tax professional before doing this, to make sure it is done correctly and the consequences confirmed and understood. Among potential things to be considered include "kiddie tax" and effects on college financial aid.

 

[BadAtGolf]

Do you have your own company, if so you might want to start a new thread and ask about 401K advice since it's new for you.

There are differences based on the type of company you have and if you have employees or not.

Sort of. We were acquired this year so I’m a minority shareholder now - but I essentially have free reign to continue operating how I’d like.

Until this year we offered equity as an incentive and avoided a 401k plan due to the cost. We just started it this month. I’ve participated in previous plans, but for the last 6-7 years all my money has gone into the company.

 

[BadAtGolf]

If the beneficiary designation on the IRA was per stirpes, consider disclaiming. IRA would go to your children. They would still be subject to the ten year rule (even if they are minors they would not have the more favorable EDB status as they are not the children of the owner) but depending on their ages and incomes this would likely save taxes.

Of course, consult with an attorney or tax professional before doing this, to make sure it is done correctly and the consequences confirmed and understood. Among potential things to be considered include "kiddie tax" and effects on college financial aid.

This is brand new to me, but I believe it is per stirpes. I’m confirming with the executor. I’ll have to talk with my wife about the option of disclaiming and passing it down to our kids. I assume the 10 year rule would still apply, it would just be taxed at the children’s rates which should be much better?

I appreciate the comment. Lots for me to learn. I’m not sure they’ll qualify for any financial assistance, but definitely a lot to look into.

 

[bingybear]

Make sure you know what you have and how each is handled. Consider if one inherits a previously inherited IRA

 

[Scratchy]

it would just be taxed at the children’s rates which should be much better?

To some degree perhaps but google "kiddie tax".

BTW assuming you were designated a beneficiary of the IRA account, this is a matter between you and the custodian of the account, not the executor.

 

[badatmath]

I think you have to take the deceased's RMD for the year in which they died. (Unless they already took it all). Then you can do whatever for the next years.

 

[BadAtGolf]

I think you have to take the deceased's RMD for the year in which they died. (Unless they already took it all). Then you can do whatever for the next years.

My SIL is the main point of contact with the relative who is over this so I’m getting info second hand, but I believe she said they took out the RMD before reporting the death. They will use the funds for funeral and all the other end of life expenses.

It’s crazy how complicated this stuff is. No idea how the average person navigates it without giving a lot of extra money to the government.

 

[SecondCor521]

This is brand new to me, but I believe it is per stirpes. I’m confirming with the executor. I’ll have to talk with my wife about the option of disclaiming and passing it down to our kids. I assume the 10 year rule would still apply, it would just be taxed at the children’s rates which should be much better?

I appreciate the comment. Lots for me to learn. I’m not sure they’ll qualify for any financial assistance, but definitely a lot to look into.

My plan is to partially disclaim 75% of my portion of a traditional IRA that I'm likely to inherit. Since I have three kids and the beneficiary designation is per stirpes, the end result will be that my portion of the IRA will be equally divided between the four of us.

Each of us will then have 10-ish years to draw down the account, which I plan to do by taking equally over that period, adjusting of course for any other tax things (like in your case having a couple years of higher income up front).

Dividing the money among four people across 10-ish years means that each person each year has a smaller amount of income, which would generally fall into lower brackets rather than higher.

Note that partial disclaimers have some prerequisites (must be permitted by federal and state law), and there are requirements to meet, including timing and notification requirements.

...

The only tricks I know about inherited IRA are two:

1. Generally you have 10 years to drain it. But some special cases the 10 year rule may not apply. You could check to see if you qualify as a special exception. IIRC these are things like permanently disabled beneficiaries, beneficiaries under age 18, spouses of the decedent, or maybe(?) beneficiaries within 10 years of age of the decedent.

2. The 10 year rule is not exactly 10 years. It's 12/31 of the year containing the 10th anniversary of the date of death. So assuming the person died this year, that would mean you have until 12/31/2031. Which, if you can take a distribution this year, you actually have 11 tax years, not 10. This is probably not that helpful since you're high income this year, but maybe the other beneficiaries (like your kids) could make use of this.

...

People have mentioned kiddie tax. Kiddie tax applies if your child has investment income above a certain amount in a given year. Income from an inherited traditional IRA is not investment income. Therefore the kiddie tax is not a direct consequence of the kid inheriting a part of the traditional IRA. (Of course, if they take distributions then invest those, eventually they'll have investment income that might trigger kiddie tax.)

...

Previous poster is correct that the beneficiaries collectively must finish the decedent's RMD in year of death if the decedent hadn't.

...

Depending on how old your kids are, their inherited IRA income might adversely impact their financial aid. But you're probably still money ahead to split it with them as long as you don't need the money.

 

[Scratchy]

1. Generally you have 10 years to drain it. But some special cases the 10 year rule may not apply. You could check to see if you qualify as a special exception. IIRC these are things like permanently disabled beneficiaries, beneficiaries under age 18

The ten year rule will apply in this case even if the OP's kids are under 18. The beneficiaries under age 18 rule exception only applies if the minor beneficiary is a child of the decedent.

People have mentioned kiddie tax. Kiddie tax applies if your child has investment income above a certain amount in a given year. Income from an inherited traditional IRA is not investment income. Therefore the kiddie tax is not a direct consequence of the kid inheriting a part of the traditional IRA. (Of course, if they take distributions then invest those, eventually they'll have investment income that might trigger kiddie tax.)

If you are stating distributions from the IRA are not subject to the"kiddie tax", that is not correct. The kiddie tax applies to unearned income, including distributions from an inherited IRA.

https://www.nolo.com/legal-encyclop...iddie-tax-when-leaving-an-ira-to-a-minor.html

 

[CRLLS]

........ I tried searching the forum but couldn’t figure out how to find “inherited IRA” and not either of the words individually, so i apologize if this has been discussed recently - and I welcome links to those threads. ........

I won't add to the advice already given. I will tell you how to search like you wanted to. Google site:
(then the web site you want to search) space then the words or phrase you want. It works here as well as many other sites. So many that I have not found one where it doesn't.

site:early-retirement.org "inherited IRA"

As has been said, money is fungible. I therefore consider situations like this to be a time to rethink my entire plan rather than treat it separately. DW and I are doing just that with her recent Inherited IRA. We decided to kick the can down the road, and reconsider options each year. We have 10 decisions to make, each 1 year apart.

 

[cathy63]

My SIL is the main point of contact with the relative who is over this so I’m getting info second hand, but I believe she said they took out the RMD before reporting the death. They will use the funds for funeral and all the other end of life expenses.

It’s crazy how complicated this stuff is. No idea how the average person navigates it without giving a lot of extra money to the government.

At some point you do need to figure out what exactly happened, because it's going to affect your taxes. There's no grace period when someone can take an RMD on behalf of the decedent before reporting the death. The date on the death certificate is the one that the IRA custodian will use to figure out who gets the 1099-Rs next February.

If the withdrawal was taken prior to the date of death, then it goes to the account owner and will appear on his final tax return. If it was after the date of death, then it goes to the beneficiaries, and the custodian will most likely just distribute it evenly among all of you if nobody has given them other instructions. If the relative who is managing things took your portion of the RMD and used it to pay for funeral and end-of-life expenses, that does not relieve you of the tax burden.

 

[Scratchy]

If the relative who is managing things took your portion of the RMD and used it to pay for funeral and end-of-life expenses, that does not relieve you of the tax burden.

If someone took money from the account after the date of death to pay for funeral or end of life expenses, that was not part of any beneficiary's RMD. I don't know what that would be considered other than fraud or theft, even if not intended as such. You may not want to pursue this aggressively but I'd consult with an attorney to make sure it is handled properly from a tax point of view and to protect everyone from future action by any beneficiary.

 

[SecondCor521]

The ten year rule will apply in this case even if the OP's kids are under 18. The beneficiaries under age 18 rule exception only applies if the minor beneficiary is a child of the decedent.

If you are stating distributions from the IRA are not subject to the"kiddie tax", that is not correct. The kiddie tax applies to unearned income, including distributions from an inherited IRA.

https://www.nolo.com/legal-encyclop...iddie-tax-when-leaving-an-ira-to-a-minor.html

Appreciate the corrections. You're right on the kiddie tax issue. On the beneficiary under age 18, I was being approximate in my description and hoped OP would investigate further. I didn't check on that one, but you sound confident so you're probably correct.

 

[disneysteve]

If someone took money from the account after the date of death to pay for funeral or end of life expenses, that was not part of any beneficiary's RMD. I don't know what that would be considered other than fraud or theft, even if not intended as such. You may not want to pursue this aggressively but I'd consult with an attorney to make sure it is handled properly from a tax point of view and to protect everyone from future action by any beneficiary.

I second this. As soon as the person died, that account became the property of the beneficiary. Nobody else could legally take money from that account for any reason. That includes the executor.


If there wasn't a large sum involved, it might not be worth making a fuss about, especially depending on what your relationship is to the person involved. But if it was a substantial amount, you might want to think about mentioning it.


A lot of estates get mishandled purely because the people involved don't know what they're doing, not because they were purposely trying to do something fraudulent.


It sounds like it doesn't apply here, but just as a general note, if the deceased hadn't yet needed to start taking RMDs, then it isn't necessary for the beneficiary to take one on their behalf. That's the situation I have with the IRA I inherited this year. My late cousin was 66 so wasn't subject to RMDs yet so I don't need to make his 2021 withdrawal.

 

[BadAtGolf]

Thank you. It’s my wife’s grandmother. Wife’s mom passed away a few years ago, so her portion is split among her kids. That means an Uncle-in-law (is that a thing) is in charge of this and I don’t know him. I will check with my SIL who is managing things for the grandkids, but I don’t want to rock the boat too much while the Uncle is dealing with the passing of his mother.

If it turns out he took a large sum, I’ll deal with that. I need to better understand how the RMD works and how it will effect me if his withdrawal doesn’t count. I’m guessing that means I have to take a RMD equal to our portion of the inheritance by end of year? Are there penalties if I fail to do so?

 

[SecondCor521]

I’m guessing that means I have to take a RMD equal to our portion of the inheritance by end of year? Are there penalties if I fail to do so?

Basically, your Grandma-in-law's 2021 RMD must be satisfied before 12/31/21 by her and any combination of her beneficiaries. The beneficiaries can satisfy any shortfall (if Grandma hadn't taken her full RMD before passing away) in any apportionment they choose. I'm not sure what happens if they can't agree.

If an RMD is not satisfied, the penalty is 50% of the amount that should have been taken but was not. In the transitional year-of-death situation with multiple beneficiaries, I am not sure how it is apportioned. The relevant discussion might be found in the instructions for Part IX of Form 5329, or in Pub 590-B.

 

[disneysteve]

If it turns out he took a large sum, I’ll deal with that. I need to better understand how the RMD works and how it will effect me if his withdrawal doesn’t count.

If he took money out after her death, that ought to count toward the 2021 RMD regardless of why he did it or what he did with the money. The problem is he took that money out illegally as he had no legal right to access the account.

 

[BadAtGolf]

If he took money out after her death, that ought to count toward the 2021 RMD regardless of why he did it or what he did with the money. The problem is he took that money out illegally as he had no legal right to access the account.

He’s been managing her money for years as her health declined. Not sure if that matters, but I don’t think it was out of the ordinary for him to withdraw money to cover her expenses.

Now, that money became other people’s money the minute she died, so I get what you’re saying. Technically, sounds like it was illegal. Assuming he took the RMD to pay for expenses and prevent the rest of us from paying penalties with such short time left in the year, I don’t think there were ill intentions.

Family matters aren’t always black and white, even if the law is.

 

[cathy63]

Thank you. It’s my wife’s grandmother. Wife’s mom passed away a few years ago, so her portion is split among her kids. That means an Uncle-in-law (is that a thing) is in charge of this and I don’t know him. I will check with my SIL who is managing things for the grandkids, but I don’t want to rock the boat too much while the Uncle is dealing with the passing of his mother.

If it turns out he took a large sum, I’ll deal with that. I need to better understand how the RMD works and how it will effect me if his withdrawal doesn’t count. I’m guessing that means I have to take a RMD equal to our portion of the inheritance by end of year? Are there penalties if I fail to do so?

If you know the age of your wife's grandmother and the amount of all her IRAs put together, you can figure out what the RMD should have been. Use any online calculator or find the IRS' look-up table. If the grandmother was 85, then she had to take 6.8% of the value out of the accounts. If she was 95, then 11.6%.

Best case, her son had power of attorney and saw that the end was near and went ahead and made the withdrawal before she died and things were just slightly miscommunicated when you heard about it third-hand. In that case, the taxes will be paid on her final tax return. The cash is in the estate account and can legitimately be used for final expenses.

If he did make the withdrawal after death, then probably the full RMD amount has been taken since it sounds like he knew about the requirement. Even if he technically took it illegally, the IRS is going to be satisfied as long as the 1099-Rs are issued and everybody pays their taxes. If nobody tells the custodian otherwise, then they are going to assume everyone agreed to a proportional split which you should be able to calculate out. I guess the custodian might figure out that this withdrawal was done during a time that the account should have been frozen and they might have some questions for the Uncle, but that's not on you. Any cash that's left over after paying for the funeral should be distributed as per the will, which is probably the same as the IRA beneficiaries, so you might be getting some after-tax money that you can use to pay the taxes on the RMD.

 

[BadAtGolf]

If you know the age of your wife's grandmother and the amount of all her IRAs put together, you can figure out what the RMD should have been. Use any online calculator or find the IRS' look-up table. If the grandmother was 85, then she had to take 6.8% of the value out of the accounts. If she was 95, then 11.6%.

Best case, her son had power of attorney and saw that the end was near and went ahead and made the withdrawal before she died and things were just slightly miscommunicated when you heard about it third-hand. In that case, the taxes will be paid on her final tax return. The cash is in the estate account and can legitimately be used for final expenses.

If he did make the withdrawal after death, then probably the full RMD amount has been taken since it sounds like he knew about the requirement. Even if he technically took it illegally, the IRS is going to be satisfied as long as the 1099-Rs are issued and everybody pays their taxes. If nobody tells the custodian otherwise, then they are going to assume everyone agreed to a proportional split which you should be able to calculate out. I guess the custodian might figure out that this withdrawal was done during a time that the account should have been frozen and they might have some questions for the Uncle, but that's not on you. Any cash that's left over after paying for the funeral should be distributed as per the will, which is probably the same as the IRA beneficiaries, so you might be getting some after-tax money that you can use to pay the taxes on the RMD.

You’re saying I may owe taxes on the money he withdrew after she died? Even though I never touched it?

I guess the RMD had to happen either way and if it didn’t happen before her death, then it would likely be split evenly among all of us - meaning I’d be paying taxes anyways?

If the first part is true - that sucks. Seems like her money should be able to be withdrawn to pay for her final expenses, and be taxed at her rate. Crazy that a portion may be assigned to me and taxed at my rate which is much higher than hers.