taxable v nontaxed funds for investing

[lazygood4nothinbum]

still trying to understand all this financial stuff so not sure if i will even be phrasing my question properly.

my inheritance will be made up of cash, part of an ira and part of a house. though i don't have all the figures in from uncle accountant, i believe less than 1/3rd will be an inherited traditional ira and over 2/3rds will be cash (rather cash plus my portion of house proceeds).

does it make sense to fill up my first year or two or third-year bucket with the non ira cash in the form of stepped cd's or a money market fund since then i would pay no income tax at all during those years (well, actually minimal tax as i'm still converting my personal traditional ira to a roth)?

do tax considerations (particularly both of investing within the ira & withdrawing from the ira) mean that i will be treating these two types of money (ira & non ira) differently with respect to how & where they are invested?

and finally, when withdrawing funds, is there any advantage to having non ira money over ira money? how does that work please?

thank you.

 

[Martha]

As you know, whatever you take out of the IRA will be subject to income taxes at the ordinary income rates. So, it makes some sense to have the IRA invest in things like bonds or other interest earning investments since you would pay taxes at ordinary income rates on interest even if not in the IRA. You might want to concentrate on assets that generate capital gains and dividends in the non-IRA investments because those will be taxed at lower rates (at least under current tax laws). This doesn't mean you want only interest producing assets in the IRA and no assets that generate capital gains, but it is at least something to consider.

Also, you wouldn't want any assets in the IRA that generate tax exempt income, like municipal bonds, because you would not be able to take advantage of the tax exemption.

Are you aware of your options as to how to deal with the inherited IRA so you can take out distributions over your life expectancy? There are rules for dealing with an inherited IRA that have to be followed so that you do not end up having to get hit with a big tax in a short time.

As far as the issue of "filling the buckets," that is out of my league.

 

[Martha]

Here is an article that talks some about inherited IRAs that is pretty good: https://web.da-us.citibank.com/cgi-...ticle.jsp?BV_UseBVCookie=yes&BS_Id=SM-103&M=S

There is also the tedious IRS publication 590: http://www.irs.gov/publications/p590/ch01.html#d0e5724

 

[Nords]

and finally, when withdrawing funds, is there any advantage to having non ira money over ira money? how does that work please?

If you're going to be withdrawing from this inherited IRA for more than a few years then it's well worth a read through one of Ed Slott's books on titling inherited IRAs and withdrawing from them. Scroll down http://www.irahelp.com/index.shtml and read whichever one of them is in your local library.

 

[lazygood4nothinbum]

thanx martha. yes i understand that it is not my ira so i can't do stuff like convert it to a roth or add to it. my uncle talked about the withdrawals in terms of setting it up "like an annuity" which seems to coincide with what you said above & with your referenced web page discussing minimum withdrawals over the course of the beneficiary's life expectancy.

so if i understand, i invest mostly but not necessarily completely in bonds with the ira money but not municipal bonds because within the ira interest is not taxed and so there would be no benefit gained from muni's.

am i not investing in stocks in the ira because dividends & realized cap gains would be taxed within the ira? or would that also only be taxed at normal income tax rate upon withdrawals?

is the tax rate on investment products which might throw off dividends and cap gains much lower than regular income tax?

would i be better off having a higher percentage of ira cash or non ira cash?

as i've never invested before other than in the ira (from my ex-employer and now currently rolled over to my bank) & my house, i'm not at all familiar with how such products are taxed. is there a difference between how interest from a bond is taxed and how stocks which are sold for cap gains or which collect dividends are taxed?

when investing in stocks outside of an ira, am i taxed on all dividends and cap gains realized during the year even if reinvested or am i taxed just on what i remove from the funds to spend?

is any of this related to er or should i be discussing this with a tax guy?

edit: thanx nords. will look into this week.

 

[Martha]

While in the IRA, nothing gets taxed so it is nice to have the IRA grow tax free. But, when you take money out of the IRA it ALL gets taxed and you have to pay at ordinary income rates which are currently higher than long term capital gains rates or qualified dividend rates. So, if you have capital gains in the IRA, they don't get taxed while in the IRA. But when you take the money out it gets taxed at ordinary income rates, not the lower capital gains rates.


Say you are in the 25% tax bracket. If you had qualified dividends or long term capital gains paid to you outside of the IRA, you would pay taxes on them at only a 15% rate because of the favorable treatment these assets get under the tax code. But if you took the same amount of money out of the IRA, whatever its source, it would be taxed at the 25% rate. If you earned non-tax exempt interest outside the IRA, it would be taxed at the same rate as the money you take out of the IRA, so it would have no real adverse effect to have interest earning assets in the IRA. The only exception is for tax exempt interest. Hold tax exempt bonds outside of an IRA so you don't have to pay tax on them. If in an IRA you will pay tax when you take it out.

Outside of the IRA, you have to pay taxes on capital gains, dividends and ordinary income such as interest in the year you earn that income, whether or not you spend it.

Does that help?

You might want to sit down with someone and have them explain how it all works together; it is hard to do on a message board. Otherwise, maybe someone has an idea of a book or website which generally talks about taxes.

 

[lazygood4nothinbum]

ya thanx again martha. starting to wrap my little brain around it. for now it feels like it was much less w*rk w*rking for a paycheck. but i figured out how do that without much effort so i assume this will get easier too.