Inherited IRA that I must withdraw in 10 years

Investing
#1

This is a complex topic and I’m not expecting CPA advise. My mom passed away earlier this year and left my siblings and I a large life insurance policy. Another benefit that I didn’t expect was a large state retirement fund payout. After making a mistake that cost me time, I have the proper inherited IRA account set up with Fidelity. I know that I have to expose the money to IL tax over a 10 year period and the rules are complex.

How should I invest the money? My first thought was to invest in a target-date index fund or S&P500 fund and withdraw the minimum. I am fortunate enough to have already maxed my tax-advantage accounts for the year.

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#2

Yeah, that sounds like a wise plan to me. Optimal investing is pretty simple. Buy and hold low fee index funds. An S&P 500 index fund would be fine, or a three fund portfolio or target date index fund would be a more diversified approach. Getting more tricky won’t get you better returns, rather just open you up to underperforming the market.

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#3

@Jeremy
Jeremy,

Since the rules have changed for inherited IRA (the funds needing to be withdrawn over a 10 year period and taxed at that time), would you still recommend the ROTH IRA as an investment vehicle, if you had children who would inherit these funds? Every since I learned of this 10 year rule, I’ve been wondering why use the IRA at all. I would like the inherited funds to continue growing for my children. How can this be achieved?

Also, do your children avoid this 10 year withdrawal window by investing the funds instead of withdrawing them? Or do they make withdrawals, pay taxes, and re-invest the funds that are left to keep them growing?

Thanks

#4

Hey @dashfuneralflowers!

This gets a bit further into estate/tax planning that my experience affords, but I’ll do my best at some broad strokes answers.

I think the 10 year rule is basically the government trying to prevent that money from growing tax free forever. i.e. kids can’t keep their parents money growing in the parents IRA. But your descendents can and should use their own IRAs and 401ks to maximize their own tax-advantaged growth.

And the withdrawal doesn’t and shouldn’t mean an end to investing. It just means that money has to come out of the warm, cozy confines of a tax advantaged account. But it can and should keep growing in whatever other account makes the most sense, which might be a regular brokerage account.

So, as an example: Let’s say your Roth IRA is worth $1M upon your death. Your kids take over that account, and over the course of the 10 year withdrawal window it grows to $2M. Then they take the $2M out and put it into a regular brokerage account. Over the next 5 years it grows to $3M. Then they sell everything to buy a $2.5M house. The government THEN says “hey, that first $2M was tax free thanks to the rules of the Roth, but you just made that last million without paying any tax on it… so you owe us tax on $1M, or about $200K or so”. So your kid pays $200K in taxes, ends up with $2.8M. Buys a $2.5M house and throws a party with the remaining $300,000. So the question is, do you really want your kid burning $300,000 on a party? If not, maybe avoid leaving him so much!

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