The Tax Impact of Receiving an IRA Under a Beneficiary Designation

by Jane Meggitt

So you've inherited an individual retirement account. What you can do with this account depends on your relationship to the decedent. A surviving spouse has options not available to non-spousal beneficiaries. The tax impact of receiving this IRA depends on whether it is a traditional or Roth account, and if you follow IRS rules for either taking a lump-sum distribution or required minimum distributions.

Spousal Beneficiary

The surviving spouse may treat the IRA as her own, roll it over into her personal qualified retirement plan and continue making contributions to the account. None of these options are available to non-spousal beneficiaries. When the surviving spouse begins taking required minimum distributions (if it is a traditional IRA) she will be taxed on the withdrawals at the ordinary income rate. If the account is a Roth IRA, she does not have to take mandatory distributions, but any distributions are tax-free.

Non-Spousal Beneficiaries

Non-spousal beneficiaries have two basic options, depending on the age of the decedent. The beneficiary should make a trustee-to-trustee transfer of the account, in which the IRA is held in the name of the decedent for the beneficiary. If the beneficiary inherits a Roth IRA, the withdrawals are tax-free, but unlike the original account owner, the beneficiary does not have the option of not taking distributions.

Required Minimum Distributions

If the decedent was over age 70-1/2, the non-spousal beneficiary must take required minimum distributions based on his own life expectancy, as shown in the Internal Revenue Services's single life expectancy table. Failure to take these distributions results in a tax penalty of 50 percent of the amount the beneficiary failed to withdraw. Distributions on an inherited traditional IRA are taxed in the same manner as the original account owner, as ordinary income.

Lump-Sum Distributions

If the decedent was younger than 70-1/2, the beneficiary has the option of taking a lump-sum distribution from the account under the IRS's five-year rule. As long as the beneficiary closes the account by the end of the fifth year after the decedent's death, the IRS does not levy penalties. Any amount may be withdrawn at any time within the five-year time frame. The amounts withdrawn are taxed as ordinary income.

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