Inherited IRA
My client received a sizable inherited IRA about 4 years ago and is taking the RMD plus a little extra each year. However since the life expectancy is about 36 years from when she inherited this IRA, is this account designed to run out at the 36 years?
In addition, should she be taking out a larger yearly amount – above and beyond the RMD – and reinvesting the excess distribution above the RMD in a taxable account for future use to offset the eventual and complete liquidation of this account? Her account values have been increasing each year (up until recently).
She also has a sizable IRD to use (about $700-800K). Is there a “breakeven” point to the IRD or does it just decline as it is used?
Any and all suggestions/information would be greatly appreciated. Thank you.
Permalink Submitted by William Tuttle on Mon, 2008-08-04 21:53
[quote=”[email protected]“][quote]My client received a sizable inherited IRA about 4 years ago and is taking the RMD plus a little extra each year. However since the life expectancy is about 36 years from when she inherited this IRA, is this account designed to run out at the 36 years?[/quote]
Yes, by virtue of the divisor decreasing by one each year the account is intended to be depleted in 36 years. There could be some variation depending on excess distributions and/or market returns.
[quote]In addition, should she be taking out a larger yearly amount – above and beyond the RMD – and reinvesting the excess distribution above the RMD in a taxable account for future use to offset the eventual and complete liquidation of this account? Her account values have been increasing each year (up until recently).[/quote]
In most cases with normal distributions of returns (not a bear market) the portfolio should tend to increase for some time. She should not be taking out extra distributions unless she needs/wants the money for other reasons. Why would you want to move money from tax deferred accounts to taxable accounts and in addition pay taxes on the distributions.
[quote]She also has a sizable IRD to use (about $700-800K). Is there a “breakeven” point to the IRD or does it just decline as it is used?[/quote]
It is really a function of what the return of the portfolio is compared with what the RMD amounts are. If the return is larger the account will grow, if the RMD is larger the account will shrink. As I said, in the beginning the account should grow and later (much later it will shrink). This will fluctuate with the returns.
[quote]Any and all suggestions/information would be greatly appreciated. Thank you.[/quote]
Generally the advice is to only take the minimum distributions and leave the balance to continue to grow. There is nothing preventing her from investing the net RMD amounts or even use that money to help her max out her own 401k/IRA/Roth IRA.
However, it is really a personal decision depending on circumstances. Can she make do with just the RMDs?, does she want to retire early?, etc… There are no hard and fast rules, just that generally people are better off if they don’t see it as a windfall and deplete it fast. The long term potential benefit of limiting herself to the RMDs is enormous.
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Permalink Submitted by Donna Smith on Tue, 2008-08-05 00:00
Thanks for the information Bill. My client , who is in her 50’s, works but generates very little earned income. and uses the entire RMD for living expenses. She has very little savings. The thought process for taking out MORE than the RMD now is because as a declining IRS factor for the inherited IRA, by the time she is in her 70’s or 80’s there will be nothing left in the inherited IRA since it will net out to zero in 36 years.
By putting the aftertax money into a taxable account and NOT touching it at all – just build it up, when and if she needs the monies in her 70’s or 80’s to live on, the proceeds will enjoy lower capital gains taxes.
What are your thoughts about this? Your help is appreciated.
Permalink Submitted by Alan Spross on Tue, 2008-08-05 00:42
The long term CG rates expire after 2010, and since these rates are historically low and we are running a huge deficit, one cannot assume how long these rates will be extended, or if they are not extended for all, at what tax bracket the current low rates will survive.
The amount of future RMDs depends on the investment returns in the account. Even though the divisor will reduce by 1.0 each year guaranteeing total distribution around age 84, it is very difficult to project the dollar distribution variances throughout the 36 year period. With over a 5% return, the account would grow for the first 18 years, but to the extent the distributions exceed the actual RMD figure, all future RMDs would be reduced.
The recovery of the IRD deduction is realized as the dollar distributions come out regardless of whether RMD or not. Perhaps it makes some sense to bunch distributions according to her ability to itemize since she gets no benefit from the deduction to the extent the IRD falls under the standard deduction amount. Bunching distributions with itemized deductions could make sense, but will take considerable tax planning.
Permalink Submitted by William Tuttle on Tue, 2008-08-05 00:50
Ok, that is some additional information. This is really outside my expertise. Also, the common professionl posters and this forum is/are mostly concerned with the procedural, legal, and tax issues of retirement accounts.
However, I think you should try to make the most of the tax deferred nature of the inherited IRA. This really requires consulting someone who can really advise these specific circumstances.
I think that this situation could call for an approach of comsumption smoothing. You would plan withdrawls to smooth the net effective income over her life expectancy. This would take advantage of her earned income now and here social security income later. Also, you would consider an inflation adjusted income stream that would minimize the overall tax impact.
Since you might have lower marginal tax rates now with the smaller RMDs and much higher rates later when the divisor decreases. She should certainly consider fully funding a ROTH IRA given the earned income to do so. Also, if the additional distributions are not needed for current income, your idea of funding taxble accounts has merit. Just make sure asset locations make tax sense.
I do think you should get financial planning advice. You could also post this question on http://www.bogleheads.org. While their main focus is investing, there are many knowlegeable people their who could point you in the right direction.
Permalink Submitted by Bruce Steiner on Tue, 2008-08-05 23:37
Assuming a constant tax rate, you would always want to keep as much in your IRA as possible. You would need a zero income tax rate on capital gains to come out even. For example, assuming a constant 30% tax rate, if you have $100 in your IRA, and it doubles to $200, you will have $140 after taxes. If you take out the $100 and pay $70 tax because you want to invest for capital gains, over the same period of time, the only way your $70 taxable account would grow to the same $140 is if you never had any taxable income in your taxable account, or if the tax rate on your capital gains and any other investment income were zero.
Permalink Submitted by Al Fry on Wed, 2008-08-06 03:29
$30 tax, $70 to invest in Bruce’s example.