FIRE planning with expected inheritance

[glocklt4]

I know that GCC doesn't talk much about inheritances because he is not going to receive one, but I am trying to make sure that wife and I are planning for early retirement properly knowing that I will likely receive one within the next 15-25ish years.  I believe based on the types of accounts to be inherited and recent SECURE Act changes, it could change our retirement savings plans now.

I'm 39, wife is 36, no children (and no plans to).  We are planning to retire early in 7yrs when I turn 46, but it's likely that we'll both have some light contract work for a few years after this since we both love what we do (just not 55+hrs a week!).  We are half way to our retirement savings goal at this point but have recently ramped up our savings rate significantly to finish out in 7yrs.   

Breakdown:

• Roth 401k/IRA - 47%
• Trad 401k/IRA - 48%
• Taxable - 5%

Thanks to a generous 1:1 401k match and the ability to do mega-backdoor contributions, I will obviously continue maxing out all 401k possibilities until retirement, but we have plans to significantly increase taxable accounts so that we can use that (plus some light contract work) to bridge the gap to me turning 59.5.  I have almost always contributed to a Roth 401k to keep Traditional/Roth in somewhat of a 50/50 split due to 1:1 match, but we have been considering switching contributions to traditional due to 22% marginal rate (even though we've been at that or higher over the past 8yrs) and so that we can put more into taxable.  If we do this, we'll still increase Roth funds with backdoor Roth IRA's and mega-backdoor Roth 401k though.

Obviously no bets on anything in the future, but from inheritance I'd expect to receive (in today's $ equivalent of our current balances):

• Roth IRA - ~100% of our current Roth balance.  Inherited Roth IRA now has 10yr RMD thanks to SECURE Act, but no tax so will withdraw at end of year 10.
• Trad IRA - ~75% of our current Trad balance (though most variable since parents have RMDs from it now).  Inherited Trad IRA also has 10yr overall RMD thanks to SECURE Act, and it seems most reasonable to withdraw evenly each year if that lowers marginal rate.
• Taxable - ~2000% of our current taxable balance.

Wife and I are currently planning our retirement savings as if there is no Social Security and no inheritance, but it seems like ignoring the likely inheritance means we could cause some potentially bad tax situations where we could not do free/low tax Roth conversions of traditional accounts as GCC constantly reminds we should do in early retirement. 

A lot of this really seems to depend on timing of when my parents pass away.  Unfortunately my mother has a rare aggressive cancer and likely has around 6mo, and my father is 75.  At some point we have to face reality.  If my father lives another 15 years to 90, that leaves 8 years from our retirement to inheriting investments that could heavily increase our taxable income (ex: Trad IRA RMDs, dividends/gains on taxable acct).  I don't know that I would have enough time to do Roth conversion ladders of most of our traditional acct $ by the time any inheritance comes our way, so it makes me wonder about contributing much more to traditional accounts with a plan to convert to Roth for free.

Thoughts/Suggestions on how to approach this?  Thank you!

[gocurrycracker]

Hi glocklt4

I would think of it this way - for retirement math purposes, start including your expected inheritance $ as part of your overall portfolio. (What you are doing.)

If you are half way to 25x/33x or whatever now, then with inheritance is sounds like you are already FI.

Presumably you will inherit less than ~$22 million (or lower threshold for many States) so there is no estate tax.


Tax minimization is largely a game of marginal rates - for all IRA funds, paying 22% now is the same as paying 22% 50 years from now.

If IRA totals are within a stone's throw of the thresholds discussed in this post, then you have some opportunities to save a few percent in taxes.
https://www.gocurrycracker.com/is-your-401k-too-big-part-2/


If the whole family is on the tax minimization team, then you can "plan" actions in stages:
- present day
- father's lifetime
- pre-retirement (still working)
- retirement (pre-Medicare)
- retirement (post-Medicare)
- RMD

Some of these stages could overlap. The word plan is in quotes because at best we are guessing.


Present day
You pay Y (22%? or whatever.) Your parents pay X%. If X < Y, your parents can do larger Roth conversions now.
One example: how I am thinking of it for GCC Jr
https://www.gocurrycracker.com/the-secure-act-compression-of-the-stretch-ira/

Father's lifetime 
With the same number of assets but filing as single, RMDs will be taxed at a higher marginal rate.
https://www.gocurrycracker.com/the-real-death-tax/

One way to reduce the impact could be to have your Mom bequeath funds to you directly - may or may not be tax advantageous.


Retirement - pre-Medicare
If you are on the ACA for health insurance, those mandatory withdrawals could be expensive, tax wise
https://www.gocurrycracker.com/obamacare-optimization-early-retirement/


Retirement - post-Medicare
With no ACA, now can be a good time to boost Roth conversions to arrive at RMD age with smaller Traditional accounts

[glocklt4]

Thank you very much for your reply.  I agree, with a conservative expected inheritance included we are already ~40x FI, but continuing our plans as if we aren't and aiming for 30-35x in ~7yrs.   The retirement date is driven partially by benefits rather than investment goals only.  If we make it through all 7 of those working years without both of my parents passing, then inheritance anytime after that would push us to increase our expected yearly retirement spending since we'd be something like 60+x and the $ would outlive us with no children, even with significant philanthropy.  Estate tax will not apply luckily (unluckily? haha).

I misspoke before - we were actually in the 24% bracket in 2019, and should continue to be until the expiration of TCJA, then 2 years of whatever is in store after that.  My parents currently cycle between 22-24% depending on investment income, so working with a moving target of 2% difference probably isn't worth the effort, but as you point out that could jump up to 32-35% when my father has to file single - a much bigger deal.  It is difficult for them to estimate taxable income prior to EOY, but I will try and push them get a better idea.  Additional Roth conversions this year and next year (if my mom makes it into 2021) may be a good idea, especially if they will be in 22% or less. 

Agree on planning in stages.  It's obviously a delicate subject with my mom's health deteriorating, but an important one I've been trying to find some time to discuss with them.  Not a bad idea to investigate my mom bequeathing to us directly, but they do have a trust setup which might complicate that.

Appreciate the links - I did find the one about GCC Jr which was very helpful, and am trying to comprehend the 401k too large articles.  Healthcare is indeed a major concern in general after I stop working (giving up completely free healthcare will be pretty difficult!), and we have more to figure out there with expectations of living outside the US a while as well.  We'll worry more about that closer to retirement time.  Good idea about Roth conversions post-medicare.

BTW, we have the same plan as you buying a sailboat, which is another reason we are significantly increasing our taxable savings.  Boat purchase and 10-20% value in expenses per year adds up!
 ASA 101/103/104 complete and doing 114 this weekend, and we have bareboat charters setup for the next couple of years and will continue to do that at least once a year as we finish out our careers!  Charter in BVI a couple years ago was a bad idea haha .

Thanks again for your advice!

[gocurrycracker]

I would put together some marginal rate guesstimates for the different life stages -

One possibility:
- present day (24%)
- father's lifetime (32%+)
- pre-retirement (still working, SECURE Act 10 year withdrawals) (35%+ )
- retirement (pre-Medicare) (27%+ - 12% federal, 10-15%+ ACA)
- retirement (post-Medicare) (12%+ - but probably higher due to intentionally larger Roth conversions)
- RMD to age 80 (12%+, optimistically) --> (higher with Social Security)
- RMD 80+ (22%+)

Assuming some level of accuracy here, you won't have a marginal rate of <24% until age 65.

Based on the math in the 401k too big posts, if your TIRA accounts are under ~$2.0 million at that point, you could potentially pay <22% going forward. (25 years of 7% real growth = today's TIRA value of ~$375k.)

[glocklt4]

Thanks again for your recommendation on trying to estimate brackets across different life stages.  We've been going through these and your list above seems reasonable (based on tax/medicare rules of today).

As an update, I wanted to post good news that my mother is pretty stable due to some amazing immune treatments.  She's a huge fighter and doing everything possible to beat her adrenal cancer.  While no one knows what the upcoming months/years will bring, we are very grateful for this. 

Additionally, my father and I were able to spend a lot of time running 2020 tax estimates (not an easy feat!), and just did a ~15% Roth conversion thanks to the lack of 2020 RMDs and the ability to harvest some losses in his taxable accounts to eliminate all capital gains and produce a $3k net capital loss for 2020 (and slight loss carryforward to 2021 probably), freeing up more 24% conversion space.  Just a waiting game at this point to see how accurate we were, and I think the plan will be to continue conversions like this into 24% until my father has to file as individual (though RMDs are likely in 2021+ and will reduce the amount to convert by that much).  As an individual, he will never fall below 24%, so no harm in converting now except for the cash to pay taxes on it and maybe the IRMAA-1 to 2 jump for 2022, which we don't even know would affect them both anyway. 

I've learned a lot about how NIIT and IRMAA work, and how the "cliffs of IRMAA" are horrible for planning (and are based on MAGI, including tax-free interest and SS portions).  Also, we don't even know what the IRMAA brackets will be yet, so have to guess the same or similar increases to last year... ugh.  You give up some of the top 24% conversion space in order to stay below IRMAA-3, otherwise a couple is looking to pay $2604 of additional "tax" in Medicare B & D premiums alone (essentially another 5.2% minimum equivalent tax if you managed to completely fill the $276-326k space, but that will almost never happen and the effective tax rate on that premium is even higher).  Since $1 over the IRMAA-2 level pushes you to IRMAA-3, we went back and forth about whether to build a good sized buffer or just go over it on purpose to avoid the situation where we went $1 over and "gave up" the upper 24% space for no reason and they still had to pay the IRMAA-3 level premiums.  In the end, decided on a $7-10k buffer to stay below IRMAA-3. 

Anyway, I've also obviously learned how important it is to avoid this situation ourselves in the future, so we will do everything we can to convert in the bottom brackets while we're younger!

[gocurrycracker]

Very good news! On all fronts!

Well done on threading the needle with all of this - sounds like you found the right balance with lots of unknowns and difficult tradeoffs.

Would you be interested in writing a guest post about your experience to help others do the same? The cliffs of IRMAA would be a cool band name and an even better guest post

[glocklt4]

Sure!  I'd say we should probably wait until after we get all of his tax info in and figured until we do that though, in case somehow we missed something that would change my recommended method.

[gocurrycracker]

sounds good! Thanks!