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I am the beneficiary of what was left in my mom's state pension fund. I don't know how much it is, but the state estimates most people run through their pension funds (when they chose that option) in 10-12 years. She had been retired not quite 9 years.

If I take it in cash, 20 percent is deducted for federal taxes. However, she also left me a house with a mortgage ($119,000 at 3.875%) and a second ($39.000 at 7.875%). Unfortunately, I don't know how much is in the fund and when I called CalPERS, they couldn't or wouldn't tell me. However, it's possible there is enough to pay off at least one of the mortgages. I believe the 20 percent for federal taxes would be more than offset by what I would save in paying interest. As I intend to live in the house, it would also cut my mortgage payment.

On the face of it, this seems like the most prudent course, but I am not an expert in finances. Is there anything in this equation I'm not accounting for? Would rolling the funds into an IRA be wiser?

  • If I did the right math, the break-even point would be 3 years for the second mortgage and a bit under 6 for the first so you'd want to pay the mortagages down til you've got that much left on each and put the rest (if any) into an IRA. That said, are you sure the 20% is the final tax amount or is that just withholding and then you have to figure it as income with your regular taxes? I don't know how state pension funds are taxed on death, but (AIUI) normally there would be no tax until >11M (entire estate) and then 40% of everything over that, whether or not you put it into an IRA. – Kevin Feb 8 at 22:59
  • Thanks Kevin! Honestly I'm not sure of anything. Every step of the way I'm wondering if I'm doing things right, making the best decisions. My assumption is that taxes need to be paid on the pension because it was withheld pre-tax. I guess I should find out if the amount withheld will cover all pending taxes. It's a bit aggravating that I can't find out what the amount is. – Sarah M. Feb 9 at 20:25
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Many state pension funds are effectively (not actually) converted into annuities in the sense that monthly pension payments (whose amounts are determined by number of years of service and salary level) continues till the pensioner passes away, or in some cases, payments at a reduced level (50% is typical) are made to the surviving spouse of the pensioner till the spouse passes away. And yes, most pensioners "burn" through the money accumulated in their pension plan within a few years of retirement (I burned through mine in 8+ years). Pension payments continue, though, till the pensioner or pensioner's spouse passes away even though all the money accumulated has been used up; that's what the state is on the hook for.

That being said, after 9 years in retirement, there is likely not much left in the pension fund, and the death benefit is likely to be small or nonexistent; a fixed amount of $1000 from my state (which is not California). But, even if the death benefit is substantial, remember that the mandatory 20% tax withholding is tax withholding, and, depending on what your other income is, you might get some of it back as a tax refund. Note also that in general, paying down a mortgage in part does not reduce future monthly mortgage payments which continue to be the same as before; what a partial payment does is reduce the number of such payments that you will make in the future, that is, the mortgage is paid off sooner. There is also the question of whether you can "take over" the mortgages, or whether the mortgages became immediately due when your mother passed away, as many mortgages are wont to do. In the latter case, you can arrange for your own mortgage loan, based on your financial status and FICO score etc but the interest rate and payments might be different. When you officially "inherit" your mother's home (meaning the county property rolls are updated to make you the new owner), the county recorder will discover that there are mortgage liens on the house and so will not record the new ownership. It is not a good idea to simply keep mum about Mom's death, not telling the mortgage companies that Mom has passed on and just live in the house, continuing to make mortgage payments and property tax and home owners' insurance payments and the electric bill etc without having the change in ownership recorded in the land deeds. Some day in the future, the mortgages will be paid off in full, and the mortgage company will send your mother the mortgage agreement stamped "Paid in Full" and remove the lien that it has on the property, and the fit will hit the shan.

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Unfortunately, I don't know how much is in the fund and when I called CalPERS, they couldn't or wouldn't tell me.

This. This is why I'd strongly suggest you request it be transferred to an IRA, a direct transfer to a IRA that is designated "Beneficiary IRA".

The worst case if you simply take the money, is that it's a large sum (whatever large means to you), and adding such a sum to your own income costs you a large tax bill. As Kevin suggested, 20% is simply a withholding, not the actual tax due. The tax will be at your marginal rate. Why risk such an unknown?

Once it's in that acct, be aware you will have a required minimum distribution each year, based on your own age. When you do your taxes for 2018, you can see the line for 'taxable income' and how much income you can add on before touching the next bracket. This will help you decide if the effort of splitting withdrawals is worth it.

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Say you are married and after the $24K std deduction (or itemized...) you are at a taxable $70K. A $7400 additional income would have a 12% tax. The next $1 or more is taxed at 22%. You can see if you are at 22%, going to 24% is a minimal cost. I offer this only because it's better to have the knowledge for an informed decision. And no surprises at tax time.

EDIT - To clarify the 22/24% I discuss above; I have experience with people drawing down an inherited IRA, and have seen large withdrawals near year end, which if split over Dec/Jan would have resulted in a top bracket of 15%. i.e. delaying half the withdrawal would have saved an extra 10% tax, as the next bracket was 25%. Now with 12/22/24, the numbers are a bit different, but the advice remains, to be mindful of what marginal rate your taxable income puts you in.

  • @BenVoigt - does my edit help clarify? If you have any helpful advice please offer it. There are times I know the numbers, but fail to offer a clear explanation that's understandable on first read. – JoeTaxpayer Feb 10 at 17:32
  • It wasn't necessary, I had simply missed the fact that there were RMDs, which do make the lower rate important. – Ben Voigt Feb 10 at 17:33
  • And her desire for large withdrawals to clear up other debt. – JoeTaxpayer Feb 10 at 17:34

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