Inherited Annuity tax advice

[Lompocgal]

Will be receiving 128,000 annuity from my Mother's trust.
$42,000 is taxable. Have the choice of taking lump sum or over 5 years.
Considering the last in first out rule which is better.

I am in the 15% tax bracket:

First year for lump sum would be 25% Tax bracket
First year for 1/5 would still be 25% tax bracket

Second year for 1/5 would be 15% bracket if taxes don't go up for 2013.

3rd to 5th year would not be taxable income.

Am retired, no outstanding debts.
Thanks in advance!

[disneysteve]

Why would years 3-5 not be taxable? Would they not still be taxable at your 15% rate?

If you could truly avoid the taxes on 60% of the money, that sounds like the way to go assuming you aren't in need of this money immediately.

[Lompocgal]

taxable

As I understand the tax code, only the interest earned is taxable and that is $42,000.
If you take five payments of the $128,000 each payment is $25,600, so in year one that is all interest and taxable at 25%. The IRS rule is last in first out.

In year two, of the %25,600 only $16,400 is taxable at 25%

Then years 3-5 would be the principle and not taxable.

So is there any advantage to spreading it out to 5 years rather than take the lump sum?

[disneysteve]

In that case, it sounds like it wouldn't matter either way. Will any interest accrue during the 5 years? If so, at what rate?

Odds are you would do better to take it all at once, pay the tax, and invest the proceeds. You'd save a little in taxes by splitting it up but probably not enough to make it worth it. You need to run the numbers.

[bjl584]

I'd be inclined to take it in a lump sum, pay the taxes, then take what's left and get it invested and working for me. That's what i would do, but I'm not sure how much you know about investing, what your risk tolerance is, or what plans you may have for the money.

[jpg7n16]

Will be receiving 128,000 annuity from my Mother's trust.
$42,000 is taxable. Have the choice of taking lump sum or over 5 years.
Considering the last in first out rule which is better.

I am in the 15% tax bracket

How far away from the 25% bracket are you guys?

Keep in mind that the income tax structure is marginal. You have to fill up the bracket first before the new rate kicks in, and each dollar is taxed at the bracket it's in. I'll explain in a bit with examples below.

First year for lump sum would be 25% Tax bracket

Well, not exactly.

Lump sum would be 1 part 15%, 1 part 25%.

Tax Brackets 2012 | TaxBrackets2012.com

Let's say you are married filing jointly, and make $60k. At first glance, that would put you in the 15% bracket and $10k away from the 25% bracket.

So a lump sum would appear to be $10,700 @ 15% bracket, and $31,300 @ 25% bracket.

.....

But keep in mind that your tax bracket is based on TAXABLE income, not total income.

So you would subtract at least 2 personal exemptions ($3800 each), and at least the standard deduction ($11,900 for MFJ). There may be other deductions too, tax credits, maybe 401k deductions if one of you is still working.

Meaning your taxable income would be 60,000- 3800*2 - 11900 = $40,500

Meaning you're still in the 15% bracket, but actually $30,200 away from the 25% bracket.

So a lump sum (on a $60k income) would actually be $30,200 @ 15% and only $11,800 @ 25%.

First year for 1/5 would still be 25% tax bracket

Second year for 1/5 would be 15% bracket if taxes don't go up for 2013.

3rd to 5th year would not be taxable income.

Am retired, no outstanding debts.
Thanks in advance!

Sounds like they're saying the 5 year pay down would not qualify for the annuity distribution option. So the first $42k out would be taxable, and the rest not - just like you said.

The same tax story would apply to all years 1-5, except that you don't necessarily know what the tax rates will be over the next 5 years.

However, if your pretax income falls in the 15% bracket, then you are very likely to have all the earnings be in the 15% bracket (assuming brackets don't change).

Year 1: $25,600 taxable income (all or part 15%, maybe one part 25%)
Year 2: $16,400 taxable income (same) ; $9,200 return of principal (tax free)
Years 3-5: $25,600 return of principal (tax free)

[Lompocgal]

decision

Actually decided to take the lump sum.

If I spread it out, it also will effect Medical deductions and social security taxes, this way the big tax hit is all at once and then I would go back to just mainly pension, social security and a little income from investments. Most investments are in IRA and will not be a problem until required distribution at 70 1/2.
Thanks to all who responded to help me think about this issue!