Unless an IRA is of the Roth variety, the money in the account has probably never been taxed, and the IRS rules will force the eventual withdrawal and taxation -- whether the IRA holder is alive or not. There is no rush to close out the IRA of a deceased person, and only an authorized person can make the decision on closing out the account.
The owner of an IRA designates who inherits the account when he dies, by naming beneficiaries with the account custodian. Beneficiary options include a spouse, other individuals, the owner's estate or an IRA beneficiary trust. When the owner passes away, the custodian of the IRA must follow the beneficiary rules concerning how the IRA is passed along.
Estate as Beneficiary
If the owner's estate is named as beneficiary, the executor of the estate handles the disposition of the IRA. In this case, the executor will close out the IRA and pay the appropriate income taxes on the estate's final income tax returns. The balance of the IRA money is then distributed to the heirs according to the will. Since in this case the IRA is included in the estate, the IRA proceeds would also be subject to estate taxes if the total estate is large enough to owe this tax.
If living people are named as the IRA beneficiaries, the custodian will transfer each beneficiary's share of the account to aptly named beneficiary IRAs. Each beneficiary then pays taxes on any withdrawals taken from their new accounts. A spouse beneficiary can take the inherited IRA and treat it as her own, deferring any taxes until withdrawals must be taken in retirement. Other beneficiaries must make quicker plans to withdraw the money and pay taxes. The two possible withdrawal options are to get out all of the money within five years of the owner's death or set up annual distributions based on the beneficiary's life expectancy.
IRA Beneficiary Trust
If the IRA owner named an IRA beneficiary trust as the beneficiary of the account, that trust's trustee will take control over the account. A beneficiary trust must take withdrawals from the IRA following the same rules that apply to individual beneficiaries. The trustee typically withdraws a required minimum distribution from the IRA each year and distributes the money to the trust beneficiaries. The trust does not pay taxes on the withdrawals, and the beneficiaries must claim the income and pay taxes on their own tax returns.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.