Cash out of a beneficiary account?

Question

Hello all.

I’m looking for someone to talk me out of cashing out of a beneficiary account if I’m making a big mistake. What say you?

Here’s the deal: I currently have a beneficiary account left to me by my father. He was over 55 when he passed. In 2019 I took the stretch option, meaning, for the rest of my life I take a required minimum distribution (RMD) from this account. It’s seen as income, so I pay fed and state taxes on the money received. I’m thinking it’s best to cash out now, pay the taxes (I’m going to pay them anyway) and use this money to invest in real estate. Given the assets I’m looking at I will most likely be able to purchase two properties, possibly three. By law, 20% federal and 7.75% state (MD) will be withheld. Hopefully I’ll see some of that back at tax time. I’m not sure if the real amounts matter for this conversation, ￼let’s just say I’m dealing with 100K before taxes. Also, due to it being a beneficiary account I’m not going to have to pay the 10% early withdrawal penalty.

What are the reasons you would tell me NOT to cash out this account and move it into real estate? What am I missing? Is there a better way to deal with this account?

As always, thank you for your time.

Nick

Nicholas Gessner · Answer

I am sorry to hear about that but it's awesome he left you the account. If it was your spouse leaving you an IRA you could do a roll over into your own self-directed IRA and use that to invest in real estate but with anyone else you can't do that. I assume you have income from a 9-5 also. How big is the RMD and based on that and size of the account is it enough to last years or only a few? You could always use leverage to buy multiple houses and then funnel the RMD into paying down those mortgages.

Dmitriy Fomichenko · Answer

@Scott Jensen

I would not agree with the statement that "self directing an inherited account would be a nightmare". The following statement would be accurate:"self directing an inherited account would be a nightmare WITHOUT PROPER PLANNING".

It is important to understand the impact or RMD and invest accordingly. It did work well for several of my clients who did not want to have instant tax impact.

Nicholas Grandstaff · Answer

@Scott Jensen

I appreciate your input. That’s a lot of good info. I’m really leaning towards the cash out option over the course of two or three years to avoid the heavy tax burden that will come if I do it all this year.

Thanks again.

Jeffrey Dixon · Answer

Any IRA, including an Inherited IRA can own real estate. Moving to a Self-Directed IRA would give you the option of buying real estate in the IRA. That way you would not be paying taxes on the distribution all at once. Just letting you know options.

Dmitriy Fomichenko · Answer

@Nicholas Gessner and @Nicholas Grandstaff

It is also possible to convert inherited IRA into self-directed IRA (it doesn't have to be inherited from the spouse). It must remain "inherited", in other words it will remain in your father's name, you being the beneficiary, subject to RMD, etc.

You then can invest in real estate inside of the IRA. I'm not saying that is what you should do in your particular situation (I don't have enough information to give you a specific recommendation), just be aware this is an option for you.

Scott Jensen · Answer

@Nicholas Grandstaff  I have a couple comments.

• Seems like self directing an inherited account would be a nightmare due to the required minimum distributions getting larger every year. If you're doing lending or something an inherited account works well. Buying a property in this account would be a terrible idea. There's not even a way to make additional capital contributions to an inherited account if something happens to the property and you need additional cash. (Please correct me if I am wrong on this @Dmitriy Fomichenko)
• Cashing out the plan to use for real estate could be a good idea (especially if you're already an investor and know what you're doing in this market).  Depending on the account size and your tax situation, it may be beneficial to spread the distribution over a few years in order to avoid being taxed at a higher rate.
• The RMDs for your situation are based on the IRS's Single Life Expectancy Table, not growth. You take the your age at the first year of distribution and divide the account value by the life expectancy factor. Each year you subtract 1 from the previous year's life expectancy factor to get your new required minimum distribution.
• Example: 40 years old, $100,000 account value. The table shows a life expectancy factor of 43.6 so $100,000 / 43.6 = required minimum distribution of $2,294. The next year you take the new account value (on December 31st) and divide it by 42.6, then 41.6, 40.6, and so on.
• Here's the table: Single Life Expectancy Table
• I don't know your situation so this certainly isn't professional financial advice, but if I were in your shoes, I may look at withdrawing just enough each year to fill up the lower tax brackets. I wouldn't want to deal with the headache's of owning RE in an Inherited IRA.

NOTE to anyone else reading this, they changed the way beneficiary IRA's are treated so this is not a formula you can use for anyone who has died after December 31, 2019.

Nicholas Grandstaff · Answer

@Nicholas Gessner

The RMD, so I’ve been told, will be distributed over my life expectancy (90 something). I’ve taken two distributions at this point and the second distribution was twice the amount as the first. I’m assuming the amount of each distribution is dependent on multiple projections about the market and growth.

I could move the RMD into a Roth as I collect it. However, I’m 40 y/o and at some point, potentially I’ve already reached this point, time won’t be on my side to keep investing that way. Time is what has me looking at the option of cashing out and moving the funds into cash flow positive real estate.

Cash out of a beneficiary account?

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