Tax Consequences for the Beneficiary of a Decedent's IRA

Take action as soon as possible after you inherit an IRA to avoid a tax surprise.
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When you inherit an individual retirement account, also called a beneficiary IRA or decedent's IRA, you can't just ignore it. The rules for an inherited IRA are somewhat different, and you can end up with a big tax bill if you're not paying attention. Your tax liability depends on what you decide to do with the IRA.

Inherited IRA Options

What you do with an inherited IRA depends on your relationship with the deceased and the type of IRA. If you were married to the person, you have the option of treating the IRA as if it were your own, whether it was a traditional or Roth account. You don't have to take money out just yet, and you can make contributions. If you weren't married to the deceased, you have three options. You can take all of the money right away, spread out your withdrawals over the course of the rest of your life or take the money out over the course of five years. You can also choose one of those options if you are the spouse of the deceased.

Income Tax

Whether or not you need to pay income tax on the amount in an IRA depends on whether it was a traditional or a Roth account. If it was a Roth IRA, and the account was open for five years or longer, you don't have to pay income tax. But if you inherit a traditional IRA, you are responsible for tax on the original contributions and the earnings. You'll pay the income tax in the year you receive the money. For example, if you take a lump-sum distribution, you'll owe tax on the entire amount and risk pushing yourself into a higher tax bracket.

Early Withdrawal Penalty Tax

The early withdrawal tax, usually 10 percent, doesn't apply when you inherit an IRA and start taking withdrawals from it, unless you were the spouse of the deceased and decide to treat the IRA as your own. In that case, you'll need to pay a 10 percent penalty tax on top of regular taxes on the withdrawal if you start taking distributions from the account before you turn 59 1/2 years old.

Required Minimum Distributions

When you have a traditional IRA, you need to start taking required minimum distributions each year after age 70 1/2. If you inherit an IRA from someone who was older than 70 1/2, you might end up paying a 50 percent tax penalty if that person didn't take out the required minimum for the year of the death, and if you fail to withdraw the minimum amount by Dec. 31 of that year. If your spouse is over age 70 1/2 and dies, and you decide to treat the traditional IRA as your own, you'll still need to take the RMD in the year of his death to avoid the penalty.

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