Roth convert or inherited IRA drawdown?

[MuirWannabe]

This time last year, DW inherited about $1.1 million in traditional IRA’s. I promptly invested them in VTI & VOO. In the year since they’ve obviously dropped and are around $900K now.

I also have my own traditional IRA that I had been Roth converting in previous years.

I’ve been paying decent sized quarterly tax estimates this year in anticipation of starting to withdraw from the inherited IRA’s since we have just 10 years to get them to zero. But my question is given current market, should I proceed with inherited IRA drawdown or should I Roth convert.

It seems like I should reconsider, and give the inherited IRA’s time to hopefully recover. And meanwhile Roth convert while the market is down to realize those gains in a Roth.

Is my thinking correct? Does it matter? Thanks for your thoughts.

Muir

 

[RunningBum]

It seems like I should reconsider, and give the inherited IRA’s time to hopefully recover. And meanwhile Roth convert while the market is down to realize those gains in a Roth.

Taking the accounts one at a time:

Inherited IRA: It doesn't really make sense to let the recovery happen in a tax deferred account. You'll just be paying more in taxes when you eventually withdraw. It's better to withdraw while the market is down. You can continue to invest in that same fund in your taxable account, and let it hopefully recover and you hold it more than a year to allow for the gains to be taxed at more favorable rates.

Traditional IRA: You are correct here, converting while the market is down is preferred so that the recovery gains are tax free in your Roth.

Since both accounts favor paying the taxes while the market is down, you have to decide which is better. You only have 10 years to withdraw from the inherited IRA, but tax wise this year it's better to convert so that the recovery can happen inside the Roth. I'd probably do the withdrawals because that 10 year window is looming. I probably wouldn't want to wait and do a lump sum in the 10th year at a very high tax rate, but your tax picture might be different than mine.

I was going to ask how large the trad IRA is and how close to RMD age you are, but I'm not sure if that changes the answer. If you need that money for near term spending that favors the inherited IRA withdrawal.

 

[MuirWannabe]

Taking the accounts one at a time:

Inherited IRA: It doesn't really make sense to let the recovery happen in a tax deferred account. You'll just be paying more in taxes when you eventually withdraw. It's better to withdraw while the market is down. You can continue to invest in that same fund in your taxable account, and let it hopefully recover and you hold it more than a year to allow for the gains to be taxed at more favorable rates.

Traditional IRA: You are correct here, converting while the market is down is preferred so that the recovery gains are tax free in your Roth.

Since both accounts favor paying the taxes while the market is down, you have to decide which is better. You only have 10 years to withdraw from the inherited IRA, but tax wise this year it's better to convert so that the recovery can happen inside the Roth. I'd probably do the withdrawals because that 10 year window is looming. I probably wouldn't want to wait and do a lump sum in the 10th year at a very high tax rate, but your tax picture might be different than mine.

I was going to ask how large the trad IRA is and how close to RMD age you are, but I'm not sure if that changes the answer. If you need that money for near term spending that favors the inherited IRA withdrawal.

Thanks, your answer that it probably doesn’t matter makes sense.

To provide more information, currently age 60. My traditional IRA is $1.7 million.

In my head, was planning to leave any withdrawals from the inherited IRA’s in cash rather than reinvesting. Any Roth converted amount would be reinvested in similar way (VTI, VOO). So, that is certainly a difference, although I could obviously reinvest those inherited IRA withdrawals rather than leaving in cash.

And I definitely don’t want to wait for year 10 due to the huge tax hit. But that doesn’t necessarily mean I have to start the depletion this year.

 

[SecondCor521]

You can also just do an in-kind withdrawal of VTI or VOO shares from the inherited IRA if you want. It's a timing of taxation thing, not an investment allocation decision (or the two can be considered independently, at least).

If I inherit a traditional IRA, which I am likely to at some point, my plan is to basically take 1/10th, 1/9th, etc. of the remaining balance, accounting for predicted growth. You can do this easily in Excel with the PMT function.

I would also take into account any major changes in my taxation situation during that 10 year window - like if I were within 10 years of RMDs or SS start.

Personally I look at the inherited IRA withdrawals as sort of mandatory income, and the Roth conversions as optional additional taxable income. So I'd figure out the inherited IRA withdrawal plan first, then look at Roth conversions second.