With the high standard deduction under the new tax law, it may make sense to take out extra now before his income increases after graduation. But yes, you do have to take the RMDs. The accounts are tax deferred, not tax free.
Money is currently in an inherited 401K. I would check to see how efficient the 401k is, ie if there are any fees charged and the investment options that are available. I would only convert to an inherited IRA if the 401k was expensive or I was unhappy with the investment options. I think financially/taxwise there will be little if any difference between an inherited 401k or inherited IRA.
I don’t understand what the problem is with your son receiving annual distributions if he is in a very low - possibly 0% - tax bracket. (Is his income taxed at your rate? )
arguably the best time to take distributions (and I am a licensed investment advisor 
as he is likely in a 0% or very low tax bracket. Take after tax proceeds and invest in growth that will mostly be capital gains (stocks) or create Roth IRA if eligible . Either way he will experience great tax arbitrage. Might even consider overfunding a cash value life policy as that has tremendous tax treatment for distributions down stream.
How much is in the account? If you take it all out in one year will that put him into a higher tax bracket for the disbursement? You could take half out now and half after January 1 if that makes it more advantageous.
He can invest in an IRA as his earned income allows, or just park it in a mutual fund or CD.
I inherited part of an IRA from my Dad. So far, I take out the RMD in early January and the account bounces back to about the same level by the next January. Not sure if that’s going to happen this year considering the losses recently, but that’s pretty cool. I hope it goes on forever. Thanks, Dad!
Sounds like something to strongly consider, paying taxes on it when your income is zero.
But I’d stay away from anything resembling life insurance for a kid, especially if it is complicated and involves large fees to purchase and manage!
Agree that paying taxes on the funds now at low tax bracket gives your child the opportunity to find tax advantaged investments like his own Roth IRA up to the max he can contribute for next next bunch of years.
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I think @NJres hit it right on. I think the kid will have to pay kiddie tax, at the parent’s rate. So, no, not a good idea to take it all out before he graduates.
taxes will be at the rate of the owner (kid). The amount of distribution will count as ordinary income so tax bracket will depend on how much is distributed. If he has $0 income and distributes 100k, he’ll pay tax on 100k based upon whatever that bracket is. Wouldn’t recommend large distributions like that but if we’re talking 20k per yr or something small, that will leave a non worker in a very low tax bracket and allow growth to occur when he otherwise would have been in a larger bracket, hence arbitrage.
On further review, if he is a dependent his standard deduction will be much lower, and since the RMD is unearned income it will be subject to kiddie tax rules. But income you pay tax on is still better than no income. DH takes his RMD from his inherited IRA on his dad’s birthday.
@nugraddad said:
I find this absolutely impossible to believe. Accepting payment for financial advice might well require the advisor to be licensed, but come on.
Both Ds ask DH’s advice on financial matters frequently. Unethical for him to help them? No way.
formerly licensed rep <<<<<<<<<<
Like a salesman?
I think it won’t be subject to kiddie tax. Zack’s discusses this very topic here:
https://finance.zacks.com/tax-money-taken-beneficiary-ira-child-8771.html
Not sure what the date is of this article. I presume these things can and do change…
This very misleading and borderline false. The financial licensing applies to those who sell financial products products – stock brokers, insurance reps, etc. I am unaware of any licenses for strictly financial advising. Some will become a Certified Financial Planner, but that is voluntary. Many accountants, lawyers, and internet gurus provide financial advice without any special “license.”
I missed the part about it being an inherited 401(k). That means it’s still under the “control” of the employer. I would look into transferring it into an inherited IRA with a low cost firm (think Schwab, Fidelity, etc.). You’ll probably get more freedom with it in terms of investment choices, etc.
If you’re looking to reinvest the RMD, the simplest thing you can do is put it into a stock market index fund. It is very tax efficient – they have low taxable distributions and you’ll only pay capital gains tax when sold. Being young, the kid can let it ride for 40+ years. Do the math – it could turn into a nice little nest egg. Good luck.
Kiddie tax is at trust rates in 2018 on unearned income (which appears to include inherited IRA distributions according to this Forbes article from May 8, 2018).
Why didn’t the RMDs begin in the year after the year of death?
Thanks to all for all the suggestions and answers!
As far as questions that were asked, along with clarifications:
- the amount isn’t a whole lot. Barely enough for a decent down payment for an average house in these parts (Silicon Valley), that’s about it.
- my kid makes some money as a tutor and teacher in addition to being a full time student at Cal, but it’s only a few hours a week. Next year, hopefully he’ll start taking advantage of his status as a Cal CS/DS guy and hopefully get a nice internship somewhere in the summertime.
- apparently RMDs start when the beneficiary turns 18, not immediately.
- in its current form, the inherited 401K is in my kid’s name now, not in his mom’s name anymore, so there’s no employer control so to speak. Investment fees are quite low. The performance of the 401K has been pretty decent over the past 3 years, as there’s nothing speculative in there right now. It is 100% invested, all middle of the road mutual funds.
- never have used an accountant or lawyer for tax purposes, or even for fee-basked financial consulting. All the tax planning/financial planning, if you want to call it that, has been on our own. I have an MBA and my deceased wife was an accountant so we figured we would do all the planning ourselves, plus we’ve always used Schwab and Fidelity for our brokerages. If anyone has any recommendations on someone in the SF Bay area for more professional tax/financial advice, I’m willing to listen.
search for the Boglehead’s forum
There is no “no RMDs until you’re 18” rule. You may be stuck with a 5-year payout.
@allyphoe Hmmm…not sure why RMDs didn’t start then for 3 years. Maybe it’s because the 401K was transferred to my kid. Default payout is the spread out over life expectancy, unless he decides to do 5 years. It’s his choice. That’s what was presented to him.