There’s one good reason to do it, but even more not to.
My son just graduated college and currently owes $19,500 in loans. I inherited an IRA from my deceased father. This IRA is currently worth $26,000. I’m thinking of withdrawing it to pay off my son’s student loans. This IRA is separate from my retirement. This is the last year we can claim our son as a dependent, so I thought if I was ever going to withdraw it, now was the time. I understand that I will need to pay 20 percent federal tax and 5 percent state income taxes. Is there any other reason not to do this?
– Ashley G. in Missouri
Howard Dvorkin, CPA, and Debt.com chairman responds…
There’s only one good reason to act now – and three better ones for waiting.
You already cited one reason for waiting: federal and state income taxes. Together, they’ll chew up approximately a quarter of your IRA. That’s a loss of $6,500, meaning your $26,000 inheritance could amount to the $19,500 your son owes or less.
Here’s why I’m being a little vague: The 20 percent mandatory federal withholding is just an estimate. You can owe more – or less – depending on a slew of financial factors.
Let’s review the other reasons…
1. Tax brackets and RMDs
I don’t know your financial details, Stephanie, but liquidating that inherited IRA will likely push you into the next tax bracket – because the IRS considers it income. That might cost you even more money when the 2021 tax season rolls around, depending on if changes in the tax law happen.
Then there’s something called RMDs or required minimum distributions. When you inherit an IRA, you don’t have the same benefits as the original owner. That person could wait until retirement age to start drawing down the account, but when you inherit one, you have five years to drain the account. Why? Quite simply, the government wants its cut.
It’s literally called “the five-year rule,” but as part of the Cares Act, those mandatory distributions are waived for the rest of 2020. So, if you decided not to close the IRA, the good news is you have more time to choose your moment without having to worry about RMDs.
2. A new sheriff in town
One reason to wait is to see what Joe Biden will do when he becomes president next year.
On the campaign trail, Biden proposed forgiving $10,000 in student loans for all borrowers and even the entire loan balance for “those who attended public colleges or historically Black colleges and universities and earn less than $125,000 a year,” according to CNBC.
Obviously, campaign promises – regardless of the president or the party in power – aren’t something you can bank on, but it might be worth waiting a few months to see what happens.
3. Student loan relief options
In the meantime, your son can explore other ways to ease his student loan burden. The federal government offers a slew of programs that can reduce his monthly payments. Unfortunately, they’re about as easy to navigate as RMDs – which is why my advice is pretty much the same: consult a professional.
These programs have similar-sounding names, like “income-based” and “income-contingent,” but once you navigate your way through the options – and an expert can help you – your son can significantly lower his monthly payments.
One reason to do it now
I just listed three good reasons to do nothing right now with that inherited IRA. Here’s one good reason to cash it out and pay off those stubborn student loans: your son’s credit score.
Other than that, I’m counseling patience – and urging you to find a counselor. The best place to start is with credit counseling, which Debt.com can set you up with. A certified credit counselor will give you a free debt analysis, and from there, you can learn where to find a reputable tax attorney, financial planner, or student loan expert to help you. So, your first step is to call Debt.com.
Connect with a student loan specialist to find the best solution to pay off your student loans.
Published by Debt.com, LLC