Inheriting an IRA

[Necronic]

I recently had a death in the family and have inherited an IRA. On its own that is a remarkably weird experience (inheritence) because you are having a good experience (getting money) tied to a very bad one.

That aside, I am having a heck of a time understanding the rules behind this and I was wondering if anyone else has dealt with it before. The former owner was under 70 btw.

From what I understand there are 2 options:

1) Roll it over into my own IRA.

2) Cash it out.

It looks like the trustee will allow me to split up the IRA between these options as much and as often as I want for 5 years.

If I choose the cash out option for any part of it (which I would like to do for a bit of it to help with some debts) there would be an immediate 20% penalty to deal with the deferred taxes on the IRA. This cash out amount would then be considered income to me, so there would be an additional tax put on it for that.

Which would be ~20% followed by a 25% income tax based on my estimated bracket.

So if I cashed out 10k, I would get 8k, and then that would be taxed at 25%, leaving me with 6k.

Is this right? If so that is some serious bs as far as I am concerned since the freaking estate tax is currently at 0%, and for some reason I am getting taxed at ~40% for this crap.

I would seriously prefer to not have to hire a professional for this. With all the taxes coming out of this already I would prefer to keep the little bit of it that is left untouched. So if anyone has any experience with this I would definitely be interested to hear about it.

Edit: OK. I looked over the stuff on an inherited IRA a bit more. As far as I can tell the only penalty on cashing out all/part of it is that it is treated as income for myself. I'm going to need to call the company managing the IRA and find out wtf this 20% they are talking about is.

 

[Chibibar]

That is pretty much correct. You would have to report the extra income and you will be tax for it.
The penalty is for withdrawing it EARLY (I do believe the age is 65 without penalty and you just pay TAX on it unless it is ROTH IRA)

note: I'm calling my agent for my 403B. She does IRA stuff also so hopefully I will give you the official answer on what they would do in Texas

 

[strawman]

It depends completely on the type of IRA, so there's no easy way for us to advise you.

You stand to lose a few thousand dollars if you don't pay attention, though. It won't kill you to give $500-$1,000 to an accountant/tax attorney and have them figure out the best way for you to accomplish your goals without obliterating this inheritance.

Sorry for your loss, and good luck with the windfall.

 

[sixpackshaker]

What ever you do don't spend all that cash. If you are going to use it to pay of a debt, put it in a CD, take a loan against it and pay the loan off over 2 years. That way at the end of 2 years you will still be 6k ahead.

 

[Necronic]

I'm thinking more and more that I won't be touching much if any of it. For the debt (which is comprised of ~8k in 3 credit cards and ~8k car note, + student loans but those....meh) I may just tough it out and slam them down. I just got my tax return which was a nice 1.4k and all of that is going to CC's. I've also effectively cancelled 2 of those cards and have been paying them down pretty fast. In general I am paying ~1k a month and living pretty frugally considering.

It is *really* tempting to pull out ~5k of it to slam down the credit cards and leave the rest alone. But maybe....I dunno maybe this is just an oppurtunity to learn some fiscal discipline.

Edit: God I love making large payments down on a credit card. Just dumped all of my tax return onto one of them....

 

[Chibibar]

I'm thinking more and more that I won't be touching much if any of it. For the debt (which is comprised of ~8k in 3 credit cards and ~8k car note, + student loans but those....meh) I may just tough it out and slam them down. I just got my tax return which was a nice 1.4k and all of that is going to CC's. I've also effectively cancelled 2 of those cards and have been paying them down pretty fast. In general I am paying ~1k a month and living pretty frugally considering.

It is *really* tempting to pull out ~5k of it to slam down the credit cards and leave the rest alone. But maybe....I dunno maybe this is just an oppurtunity to learn some fiscal discipline.

Edit: God I love making large payments down on a credit card. Just dumped all of my tax return onto one of them....

Actually if you ARE going to do that, go with Sixpackshaker's idea. CD and pull a low interest loan vs 29.99% (upto) on Credit Cards. You can pay them back (the loan) and still have cash in case of emergency.

 

[TheBrew]

Something that might be worth considering is how much money you will save in interest by paying your cards off now vs. the taxes on the IRA used to pay it.

 

[Necronic]

right and I've considered that. Even though I do have a decent amount of credit card debt, I actually have pretty good credit, so my rates aren't anywhere near the 30% default. If I can pay off the credit cards befeore I would have accrued 25% in interest (tax rate on the IRA) then I think the IRA is a better choice.

I think.

Edit: Also, one of the things I was considering doing with this money was going back to school full time. This would be a significant expense (obviously), but I believe I can call that a hardship withdrawal and pay for it that way. Going to be a year or so before I decide to do that, but it's an interesting reason to hold on to it.

 

[Chibibar]

right and I've considered that. Even though I do have a decent amount of credit card debt, I actually have pretty good credit, so my rates aren't anywhere near the 30% default. If I can pay off the credit cards befeore I would have accrued 25% in interest (tax rate on the IRA) then I think the IRA is a better choice.

I think.

note: I am just giving advice on what I would do if I was in your shoes. I know my debt well and such (mine is higher with house and car and old CC stuff) but if you are unsure, it is better to get some expert financial advise. You should get one anyways for the IRA since that can roll into part of YOUR retirement in the future they can give much better advice.

 

[Adam]

Without knowing numbers, we're kinda feeling around in the dark here. What's your current income tax rate? What's your credit card balance? How big is the IRA? What's the return rate on the IRA? What's your credit card rate?

Knowing those, you can easily come up with the best course of action, after all it's simple math.

IF CC Balance * CC rate > (IRA Balance - (Income Tax Rate * IRA Balance)) * IRA Return Then Pay Off CC

Else

Add to your IRA

End IF

 

[KCWM]

Hey Nec, I sent you a PM/conversation

 

[Chibibar]

ok. I talk with my agent. She said if you inherit the IRA you are subject to be tax AS income only. There shouldn't be any penalties.
So if you withdrew early, you will have to pay income tax on the inherit IRA.

 

[sixpackshaker]

Also at 10K is there actually a tax on that income?

 

[Chibibar]

Also at 10K is there actually a tax on that income?

Sadly it will count toward his income if he cash it all. It could bump him to the next income bracket. I forgot what type of income (I think lotto winning falls under this) you get max tax which is luxury income or something like that.

 

[TheBrew]

So it seems like the best course is to cash out how much would get you right under the next tax bracket and use that to pay off debt (I guess depending on his current tax bracket).

 

[Chibibar]

So it seems like the best course is to cash out how much would get you right under the next tax bracket and use that to pay off debt (I guess depending on his current tax bracket).

Yea. Unless Necro is gonna disclose his financial on the web (I don't recommend it) he should talk to a certified CPA or at least Financial consultant for more details and options. Each states has their little quirks and tax laws and these professionals know all about it plus Federal level.

So states you would have to pay tax twice like state income tax AND federal level on income like inheritance (unless it is a gift under X dollars then it is federal tax free) Texas do not have a state income tax.