Financial fine point confusion -Roth IRA and other inheritance - using the money?

[luvavacation]

First, let me state that my DH and I are very, very conversative investors. We have a small amount of money invested in mutual funds, but mostly we feel better having money in our money market, where it will never lose value. Our mutual funds have lost value over the past few years, though they are doing better now. Either way, it isn't money we miss, so we are fine with that.

We have college money for our youngest mostly saved up - she starts in 2013. The eldest is finished next year, and her last year is already saved. We also have a 401K.

We do not spend money on eating out, bowling, movies, etc. We do take nice vacations, however. Those vacations are our splurge. We drive our vehicles for 10 years, and do our own yardwork and maintenance. Financially, we are fine, no credit card debt, no car payments, just a mortgage and home equity line of credit to build out our basement so my mom with Alzheimer's could live with us.

That said, my MIL passed recently, and left a very nice Roth IRA to my DH, and over the next year we will be receiving some more inheritance money as the estate is sold. The financial advisor that my DH's family has used for decades has told us not to the touch the Roth IRA, but to use the inheritance money instead if we want to pay for college, cars, home improvements, splurges, etc.

What I don't understand, and the financial advisor doesn't seem to wish to explain to me, is why would we NOT want to touch the Roth IRA? I get that the money from there is not taxable, but considering our income tax bracket now, wouldn't it make more financial sense to invest the taxed inheritance money, and take out the Roth money? By putting off the inheritance money usage until retirement, would we not be taxed on that at our retirement income tax bracket, as opposed to using it now and being taxed at a higher rate?

I am just not understanding why it is better to be taxed now on money as opposed to waiting to be taxed on it.

DH and I still have about 20 years until retirement, but DH would like to retire early and go into business for himself doing something that he loves. I support this, and have no problem once my mom passes and I am no longer her caregiver, going to work full time to help my DH fulfill his dream. It would just be nice to know the particulars of usage of inheritance money as opposed to Roth IRA money, in language I can understand!

 

[clutter]

Unless you live in certain states (such as PA), or the inheritance is pretty large, the inheritance is not usually taxed. If it is taxed, that is done at the time the funds pass, not as you use them. However, I believe that an IRA is passed as retirement funds. So, I think you would have to pay a penalty if you use the IRA, but there would be no tax once the inheritance funds pass to you.

Sorry, its a quick answer, but I'm not entirely sure if it's the 100% correct one.

 

[KennesawNemo]

First, let me state that my DH and I are very, very conversative investors. We have a small amount of money invested in mutual funds, but mostly we feel better having money in our money market, where it will never lose value. Our mutual funds have lost value over the past few years, though they are doing better now. Either way, it isn't money we miss, so we are fine with that.

We have college money for our youngest mostly saved up - she starts in 2013. The eldest is finished next year, and her last year is already saved. We also have a 401K.

We do not spend money on eating out, bowling, movies, etc. We do take nice vacations, however. Those vacations are our splurge. We drive our vehicles for 10 years, and do our own yardwork and maintenance. Financially, we are fine, no credit card debt, no car payments, just a mortgage and home equity line of credit to build out our basement so my mom with Alzheimer's could live with us.

That said, my MIL passed recently, and left a very nice Roth IRA to my DH, and over the next year we will be receiving some more inheritance money as the estate is sold. The financial advisor that my DH's family has used for decades has told us not to the touch the Roth IRA, but to use the inheritance money instead if we want to pay for college, cars, home improvements, splurges, etc.

What I don't understand, and the financial advisor doesn't seem to wish to explain to me, is why would we NOT want to touch the Roth IRA? I get that the money from there is not taxable, but considering our income tax bracket now, wouldn't it make more financial sense to invest the taxed inheritance money, and take out the Roth money? By putting off the inheritance money usage until retirement, would we not be taxed on that at our retirement income tax bracket, as opposed to using it now and being taxed at a higher rate?

I am just not understanding why it is better to be taxed now on money as opposed to waiting to be taxed on it.

DH and I still have about 20 years until retirement, but DH would like to retire early and go into business for himself doing something that he loves. I support this, and have no problem once my mom passes and I am no longer her caregiver, going to work full time to help my DH fulfill his dream. It would just be nice to know the particulars of usage of inheritance money as opposed to Roth IRA money, in language I can understand!

I don't know anything about inheritance, so what I say might not be relevant.

I belive you should leave money in Roth if you expect your annual income continue to grow and you will have a higher tax rate in the future. You will not get taxed when you take money out of the Roth account 15-20 years from now because what you put in is already taxed.

 

[nunzia]

It is so odd..I have this same situation. An aunt has left me, among other things, 1/2 of both a Roth and traditional IRA..it is very confusing tryinj to figure this out and I will talk to some professional folks before the money arrives. That said, everything I've found, it seems like taking the money out of the Roth would be fine as there would be no tax on principal..the other IRA is more confusing but if looks like there are several options, the five year one and one where it pays out to you along your age matrix..It does have to be transferred into a NEW IRA..an Inheritance IRA as the money cannot mix with yours in your IRA. Super confusing. I also wonder what the difference is on taxes..it seems to me that any taxes I'd have to pay to take the money in bulk would pretty much be the same if I took it out over time..kinda like ripping a band aid off..do you get it over with fast or just slowly pick it off..same pain, different time frame?

 

[lost*in*cyberspace]

You need to consult a new financial advisor who is willing to explain things to you until you are satisfied.

 

[mossy1]

Laws may vary from state to state but I think you have to be 59 1/2 or prove some type of hardship to draw from the IRA account. There may be other qualifying ways as well. But if you don't have proof, the penalty for early withdraw is usually quite high. Best of luck!!

 

[furb & dez]

We have a small amount of money invested in mutual funds, but mostly we feel better having money in our money market, where it will never lose value.

I won't comment to the rest of your post, but you need to be further informed.

A money market fund is a type of mutual fund. While the goal of money market funds is to maintain a $1 = $1 value, they DO fluctuate and your money is NOT guaranteed. They CAN lose value. The fed had to step in at the start of the crisis (2008-ish?) and guarantee those funds for a short period of time because the value dropped.

Nothing in finance is guaranteed. If a financial person tells you to "invest is this, it's a guaranteed return!" they are lying to you (and committing a crime).

 

[a pirate's mama]

There are many different variables that one would need to know before they could give you a correct answer, but I do think you need a Financial Advisor who is willing to listen to your concerns and explain them in a way that helps you to feel more comfortable.

For someone to answer your question correctly, they need to know what state you are from and when the Roth IRA was opened. What's more, is that as a non-spouse beneficiary, your husband will be required to take distributions from the Roth IRA much like he would have to from an inherited Traditional IRA. He would either need to distribute the entire account by December 31 of the fifth year following the year of the owner's death or receive the entire distribution over his life, or over a period not extending beyond his life. There are calculation tables frm the IRS that take into account the age of the beneficiary and it is calculated using a divisor for the age of the beneficiary into the total value of the Roth IRA on December 31 of each year.

Most people do not want to take funds out of a Roth IRA before it is necessary because of the tax-free growth they offer.

In states like Pennsylvania, you would pay inheritance tax on the assets that are not considered retirement assets whether you withdraw them from an account or not.

I hope that helps a little for you!

 

[MolonLabe]

I won't comment to the rest of your post, but you need to be further informed.

A money market fund is a type of mutual fund. While the goal of money market funds is to maintain a $1 = $1 value, they DO fluctuate and your money is NOT guaranteed. They CAN lose value. The fed had to step in at the start of the crisis (2008-ish?) and guarantee those funds for a short period of time because the value dropped.

Nothing in finance is guaranteed. If a financial person tells you to "invest is this, it's a guaranteed return!" they are lying to you (and committing a crime).

Excellent points.

I'd go a step further and tell the OP that the money is, most definitely "losing value" every year.

Current rates on MM from a competitive credit union-
$2,499 & below 0.41% / 0.41%
$2,500 - $9,999.99 0.41% / 0.41%
$10,000 - $24,999.99 0.51% / 0.51%
$25,000 - $49,999.99 0.61% / 0.61%
$50,000 - $99,999.99 0.66% / 0.66%
$100,000 or greater 0.71% / 0.71%

Even with admitted inflation rates of 3% the OP is losing over 2% of the value (buying power) every year.

Actual inflation rates are closer to 10%.

The worst things you can do with your money right now, in order of worst to... worst'er...

Stuff it under the mattress
Put it in a savings account
Put it in a CD/Money Market
Invest it in mutual funds
Invest it in stocks (without insider information.... which would be illegal)
Invest using insider information (again illegal)

Right now is a horrible time to have any savings or cash. Inflation is destroying the value and with a market... well, look at the track record, the bust hasn't actually happened yet.

In any event, if you are saving money or trying to invest, you are simply picking the best of the worst possible options right now. There really is no way to sugar coat it.

At the moment I'm riding out most of savings/retirements in ETF's and making ZERO additional contributions at this point.

To each his own, I'm up a significant amount because I liquidated most of my traditional holdings a few years ago and converted to gold and silver ETFs (along with some other options).

That can change at the drop of the hat though.

The markets are being driven by 100% greed and fear right now. There is nothing rational about it.

I'm seriously considering buying or dream/retirement house a lot early than I ever would have considered doing simply because once we own it, it's ours (unless the government raises property taxes and steals it from us at gun point).

The American dream is dying in front of us.

On the plus side, I'm not worrying about 'splurging' on things right now. I figure every day I hold onto the cash is another day the value of the dollar drops. If I could take the time, I'd be going on three WDW trips this year instead of 1... why not spend it?

 

[nunzia]

Laws may vary from state to state but I think you have to be 59 1/2 or prove some type of hardship to draw from the IRA account. There may be other qualifying ways as well. But if you don't have proof, the penalty for early withdraw is usually quite high. Best of luck!!

From what I have read it is not that simple with an Inheritace IRA..very convoluted. I agree a financial person needs to be consulted which is what I'm doing as well.

 

[Mkebound]

The best advice you can get from an internet board is to spend some money and sit down with a financial planner who charges a flat fee (not commission)

Many things will vary depending on your age, income levels, the size of the inheritance, your long term goals and the laws of your state.

 

[amcnj]

My guess would be the advisor wants you to allow the Roth funds to continue to grow tax free. The taxable accounts will have any earnings taxed now and every year for as long as you hold them. So by using the taxable funds up you are effectively cutting the taxable earnings each year, while the Roth funds will continue to grow and never create a tax obligation when withdrawn. You are not only going to be taxed on the taxable funds at a lower rate when you retire, but every year leading up to retirement earnings from them will be taxed at your current tax rates. I hope I explained this clearly.

Not sure why the advisor will not give you their reasons though.

 

[luvavacation]

Thanks for all the great advice and information!

This particular financial advisor is the one my DH wants to stay with. He has been the advisor for the family for many years, as was his father before him. He has apparently helped DH's family in a very postive way. However, he irks me to no end.

This guy is very used to people with money. We are not "well off" in the way this financial advisor expects people of DH's family to be. So, when I call to ask questions, he speaks in a way that is right over my head. I am not stupid, but I do not follow the stock market, nor have over $500,000 in liquid assets (which is the lowest dollar amount his clients have). However, I AM the financial planner for my little family, and we are doing fine with what we have, because I am frugal and have priorities with our savings. But no, we do not have $500,000 in assets.

This advisor would like to keep us as his clients because he feels he knows best for the family. I don't like anyone having any control over me. I don't like having to call someone to cut me a check for money that is mine (ok, my DH's inheritance, but you get the idea). Yet, DH feels that we will stay with this advisor out of family loyalty and with the hope that he will steer us in the right direction. I am sure he will steer us in the right direction, he has done that already for the family, but I just want to understand the direction and the why's of it, because I just like to know everything. He is not good with explanation.

You all are much better! I have made a list of questions from your responses, and will call him again for some more clarification.

The one thing I do know from him is that the Roth IRA can be withdrawn at any time, with no tax, as it is an inheritance Roth. I would love to withdraw half of it, stick it in my money market, and compare. I have been comparing the money market savings to my mutual fund savings over the last 5 years, and my money market continues to grow, slowly but surely, while the mutual fund has declined from its high a few years ago, and is less than the money market. I just don't trust the stock market, at least not when someone else is telling me what to do.

I did, on my own 2 years ago, invest small money in Home Depot stock (because I figured that people would be doing more renovations as the housing market tanked), and am now up 75%! So see, I can do something right!

Thanks again for the help and explanations. It gives me a basis on where to go with my inquiries!

 

[Sadie22]

Inherited IRAs have certain favorable terms that may be able to be maintained over the lifetime of the person inheriting. That is if the inherited IRA is retitled properly. Once the funds are withdrawn and placed in some other account or retitled in the name of the person inheriting, those favorable terms disappear. It needs to be retitled something like IRA of (deceased) for the benefit of (your DH), rather than being withdrawn and placed in any other type of account.

The advisor may have a fiduciary duty to the estate and to your husband who inherited from the estate, not to you, so he would be bound by law not to violate that trust. If your husband instructed him to explain things to you, then perhaps he could do so. Just because your husband inherits something, that does not mean that you immediately have control over it. It belongs to your husband.

Of course, this particular advisor may not be well-versed in discussing tax law and retirement funds.

 

[PatsMom]

The rules for inherited IRAs, both Roth and Traditional, can be complicated. There are tremendous tax free opportunities involved in leaving money in the Roth for as long as possible.

The advisor should set up a Roth account titled "Joe Schmo beneficiary of Joe Senior". Each brokerage will title a bit differently but it must be clearly identified as an inherited IRA. The current law will require that your husband take a distribution based on his life expectancy each year beginning one year after the year his mother died. Assuming he is young, the distributions will be small, leaving the majority of the account to continue growing tax free. In fact, even if your husband were to pass away, his beneficiary would have the remainder of your husbands life expectancy to withdraw funds. Life expectancy is based on an IRS table. The table can be found in publication 590 I think.

Withdrawals from the Roth are always tax free to a beneficiary. There is no penalty for pre-59 1/2 withdrawals. The same is true for a traditional IRA but the distributions are generally taxable income to the beneficiary (unless the decedent had basis in the IRA - then it gets really complicated!)

Failing to take the required distribution will result in severe penalties. But taking more than needed will result in losing tax free or tax deferred growth depending on whether the account is a Roth or traditional.

I am not an expert. But if you Google Ed Slott you will find his web site. He is a nationally recognized expert on the rules for inherited IRAs and is generally very easy to understand.

 

[furb & dez]

Failing to take the required distribution will result in severe penalties.

If you have an account that has a required minimum distribution "RMD" (such as a traditional IRA, and the owner is over the RMD age - generally 70 1/2), the penalty for not taking the required minimum distribution is 50%.

So if you were required (for example) to take out $10,000 for your RMD in a year, and you fail to do so, you still must take the money out - but 50% will be withheld as a penalty. Meaning, you neglect to take the $10,000 out in 2012, and in 2013 you will still need to take out that $10,000, but when you take out that $10,000 from your account, you will only receive a check for $5,000. In addition, you'll still need to take your 2013 RMD as well.

It's a painful lesson to learn. Consult with your financial advisor!

 

[SuzanneSLO]

[snip]

This advisor would like to keep us as his clients because he feels he knows best for the family. I don't like anyone having any control over me. I don't like having to call someone to cut me a check for money that is mine (ok, my DH's inheritance, but you get the idea). Yet, DH feels that we will stay with this advisor out of family loyalty and with the hope that he will steer us in the right direction. I am sure he will steer us in the right direction, he has done that already for the family, but I just want to understand the direction and the why's of it, because I just like to know everything. He is not good with explanation.

You all are much better! I have made a list of questions from your responses, and will call him again for some more clarification.

The one thing I do know from him is that the Roth IRA can be withdrawn at any time, with no tax, as it is an inheritance Roth. I would love to withdraw half of it, stick it in my money market, and compare. I have been comparing the money market savings to my mutual fund savings over the last 5 years, and my money market continues to grow, slowly but surely, while the mutual fund has declined from its high a few years ago, and is less than the money market. I just don't trust the stock market, at least not when someone else is telling me what to do.

[snip]

Thanks again for the help and explanations. It gives me a basis on where to go with my inquiries!

To the OP, you seem to be confusing the kind of investment, ie mutual fund or money market fund, with the kind of account, ie, taxable or non taxable retirement accounts. To a great extent almost iny kind of investment can be held in almost any kind of account.

When the advisor is telling you to spend money that will be in a taxable account before you spend money in a non taxable IRA account, he is not telling you how to invest the money. All he is saying is that when you earn money on the inherited money it is generally better to earn it in an account which will not require you to pay current income tax on those earnings.-- Suzanne