Inherited ira

[Notch352]

I inherited a 313k ira from my grandmother, I live in nys. I'm married filing jointly with 2 kids under 16. I make about 110k a yr wife has no income. I was going to take a lump sum. So I pretended I was filing a tax a return put my info in and federal wants 88k and state wants 23k this is absolutely sickening if correct. That's almost 50% even if I took half now and half next year it only save me about 10k I don't understand how they can take all that money it was inherited I didn't make it. Can someone please advise I have about 100k in debt I wanted to pay off. Can't ever get ahead tell you that. 

[fanfare]

Don't take a lump sum distribution.

When you are subject to the 10-year liquidation rule for newly inherited IRAs,
to spread the tax impact most evenly over the ten years,
your divisor should be :   10 - N where N is the number of annual distributions you already took.

In other words, with four years gone by, you want to take out one sixth of the IRA,
If you are a young beneficiary or even a senior, this rule would generate much larger RMD than the RMD based on Pub590B formulas.

--

Be aware that the proposed regulations from the IRS dictate that if the decedent died after their required beginning date for RMDs, both annual RMDs based on life expectancy and full distribution by the end of the 10th year following the year of death are required (which is different from what was published in the final version of 2021 IRS Pub 590-B). Annual distributions are not required only if the decedent died before the required beginning date for RMDs.

[fanfare]

Meanwhile reinvest the Inherited IRA wisely.

You have ten years to make it grow.

My rule above still works even as the IRA grows in value (nice) or loses value (sad).

@Notch352 

[dmertz]

Also be aware that you can only move the inherited IRA to a beneficiary IRA by nonreportable trustee-to-trustee transfer, not by distribution and rollover.  Once you receive a distribution from the IRA it cannot be rolled over to continue to defer taxation.

Money in this traditional IRA is generally deferred income on which your grandmother had not yet paid taxes, so you as beneficiary are responsible for paying the taxes when distributed.

$88k (28.1%) federal tax plus $23k (7.4%) state tax on $313k of income is a combined marginal tax rate of about 35.5%, not 50%.  

It seems likely that your income presently falls in the 22% federal tax bracket and that you might be able to incur another $70k or so before reaching the 24% tax bracket.  Taking all of it in one year would likely push some of it into the 32% tax bracket.  You can verify that more precisely by entering an incremental amount of IRA income, say $1,000, and seeing how much your tax liability increases.  An increase of $220 in federal tax liability for a $1,000 increase would indicate that you have a 22% marginal federal tax rate on this portion of your income.

Note that in 2026 the tax rates are scheduled to revert to the levels that were in effect before the Tax Cuts and Jobs Act of 2017 temporarily lowered them, so the 22% bracket will go back to being a 25% tax bracket.  This suggests that it may be beneficial to take roughly equal amounts over the 4 years 2022 through 2025 for these amounts to be federally taxed at less than 25%, mostly at 22%.  Of course you'll also want to take into account your state marginal tax rate on these distributions, likely making the combined marginal tax rate about 29% if taken in equal portions over the 4 years prior to 2026.  This would save you about $20k in federal taxes over receiving the entire $313k in a single year, about the best you can do.

[Notch352]

I thought about taking just taking 150 then spread other half out I have about 100k in debt that needs to get paid off. Sick of struggling to make ends meet then I think oh wow I might not have to work 75hrs a week anymore just to realize the irs gets to take most of it. Go figure. I tried putting in if I took 50k fed would take 13 state 3k then did 100k and fed would take 24352 state 6746. 150k is 36,877 state 11k, 200k 51026 state 13403 250k 65424 18024. But I forgot to check the Inherited ira box so it dropped the federal down to 81769 state stayed the same at 23066.  Where do I find out my tax bracket? I thought maybe take half this year other half next year and not work as much but even if I made 25k less it would only save me 10k in taxes. I mean I'm even if I spread it out I'm still gonna pay the same in the end won't I? Thanks for the replys.

[SteamTrain]

No...if you spread it out you would likely be paying less in taxes...but that really depends exactly on how many years you spread it  (and whether congress changes the brackets in the meantime).

One ref for tax brackets is here:

2022 Tax Brackets and Federal Income Tax Rates | Tax Foundation

______________________________

IF you look at the tables, and your current 110k income (and assuming no other income at all).

AND....Looking at Federal taxes only & using Std Deductions: 

(Bah...have to readjust some...bad math)

ROUGHLY....For a MFJ couple & 110k income to start, you'd get a ~26k Std deduction, which reduces your taxable income down to ~79 84k.  If you look at the 2022 table, that shows the first 20.5k is taxed at 10%, and most of the rest at 12%  (right up to the 22% starting break point).

IF you then also took out 100k from the inherited IRA, that adds to your taxable income, bumping it up to ~179 184k taxable income....so the first part of the 100k you added (between the starting 84k and 178k ) is taxed at 22%, then the 6k  bit from 178k to 184k gets hit at 24%.

If you take much more than 100k out of the inherited IRA, then you can see from the tables, that much of it starts to get taxed at 24%

[NCperson]

@Notch352 -  I did want to answer one of your first questions.  Remember, this is an IRA, which means your grandmother did not pay taxes on the money that was placed into the IRA.  In an Traditional IRA, those taxes get deferred....but they eventually must be paid.   And since you inherited the IRA, it's your obligation to pay it.  

It is best to stretch out the IRA over as many of the 10 years as you can - that can avoid bumping into a higher federal tax bracket - the smoother those distributions are, the less likely you will be forced into the next tax bracket.  THe more you try to take out in the 1st year, the higher your tax bracket will be.  it is a balancing act for sure! 

what year did Grandma die? assuming she died in 2020 or later, then the 10 year rule applies. if prior to 2020, then you could stretch out the distributions over your lifetime (based on an IRS table).

[Opus 17]

Because the original owner of the IRA never paid tax on the money, you must pay tax when you withdraw it. If you withdraw the entire $300,000 all at once, that will put you into the 32% federal tax bracket plus the 9% New York State tax bracket.  And I think you might also pay 3.8% net investment tax thanks to Obamacare.

You have 10 years to withdraw the money and pay tax on it. You may be able to reduce the tax you owe by taking smaller amounts out each year.  For example, if you are married filing jointly and your base income is about $100,000 per year, you should be able to withdraw about $80,000 per year from the IRA and pay 22% income tax instead of 32% income tax and you would not have to pay the 3.8% net investment tax.

If you use the after-tax portion to pay down your other debts, or you invest it to earn interest, you will be improving your financial situation in the long term even though you have to pay income tax on the amount that you withdraw.

[dmertz]

NCPerson's suggestion to stretch the distributions out over as many of the 10 available years does not take into account the tax increase scheduled to happen in 2026.  Taking that into account is why I suggested that it might be best to take it out over 4 years beginning in 2022.

The numbers that you posted for state tax liability don't seem to make sense unless there is something odd about NY state and local taxes that I'm not taking into account.  The numbers show the marginal tax rate varying between 4.8% and 8.5% which seems implausible.

The marginal federal tax rates also seem to jump around in ways that might be suggesting that there is some side effect based on the change in AGI such as in increase in the tax rate on some income (maybe long-term capital gains, but that seems unlikely in your financial situation, or net investment tax as Opus 17 suggested), a decrease in some tax credit, or just an error in the numbers you provided.

[SteamTrain]

Yeah...the NY state tax rates are really messy:

Check the progressive 2021 NY state rates Nerdwallet posted for MFJ couples:

New York State Income Tax: 2021-2022 Rates, Who Pays - NerdWallet

[dmertz]

I saw that reference.  The progressive tax rate does not explain how going from a $100k distribution to a $150k distribution incurs an 8.5% marginal NY tax rate while the next $50k (to $200k) incurs a marginal tax rate of about 4.8%.  Something has to be wrong with the numbers provided.  Income needs to get above $1M before the marginal tax rate gets above 6.85%.

The federal marginal tax rates are suspect as well.  For example, I find it odd that the federal marginal tax rate on the first $50k of distribution is 26% instead of 22%.  For MFJ, the 22% tax bracket for 2022 runs from $83,550 to $178,150 of taxable income.  Adding $50k to the original $110k is only $160k, and that's before subtracting the standard deduction.

Maybe TurboTax is adding an underpayment penalty that isn't being taken into account.  To avoid that I usually add some fixed amount of Q1 estimated tax so that the results always show a refund instead of a balance due no matter how much of a distribution is entered.  (One can also tell TurboTax not to calculate the underpayment penalty, but it's not as easy to find those settings for both federal and state.)

[NCperson]

@SteamTrain @dmertz - a close read of @Notch352 's numbers appear that he didn't indicate these were inherited IRAs on the first pass, thus it may be that  TT threw the 10% penalty. 

@Notch352 - since you are creating a dummy tax return, be sure that the 1099-R has code 4 and code A in Box 7. That will avoid the 10% penalty in the calculations which anyone under 59.5 years old normally pays (but since this is inherited, it does not apply)

[dmertz]

All of the federal tax liability numbers given would have been substantially higher (about 40% higher) had they included a 10% early-distribution penalty, so none of them do.  Code 4 in box 7 of the Form 1099-R eliminates the penalty even without explicitly indicating to TurboTax that the distribution is from an inherited IRA.  Indicating that the distribution is from an inherited IRA just prevents TurboTax from including the distribution on one's own Form 8606 in the case where one has basis in nondeductible traditional IRA contributions in their own traditional IRAs.

[Notch352]

Well before I put in any info about ira it said I owed 1800 in federal which I've never owed before and NY was giving me a 1300 refund. Maybe that's why numbers aren't right but yes I did click box 7 and code a previously I didn't and if I took 300k out it was 83646 for federal 22136 for ny then after I clicked box 7 code a it dropped it to 77534 fed 22136 state none of the state amounts changed though with any amount I put in to withdrawal just federal went down about 6k. I can put down a percentage to be withdrawal for federal and state on schwab papers should I just have them take out atleast 22% for federal and like 5% for state so at end of year I don't have to worry about coming up with that kind of money because I'm 38 and have maybe 10k to my name? If I work less to try to fall into a 2% lower tax bracket idk if I'd gain anything or not. I think I'll take out enough to stay in the 24% bracket this year and next year take other half. Thanks for the help

[Notch352]

So don't take more than 100k to stay at 22%?