Taxation of Distributions From a Beneficiary IRA
When you inherit an IRA, you may have a few decisions to make. First, your relationship to the original account owner determines what you must do and what you are able to do with the inherited IRA. Paying taxes on your inherited IRA may be unavoidable or you may be able to eliminate them altogether.
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Types
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There are two types of IRAs you can inherit. The first is a traditional IRA. Traditional IRAs are IRAs that accepted tax deductible contributions from the account holder. Taxes were paid on any distributions from the account. Roth IRAs are retirement accounts that accepted after-tax contributions and did not tax withdrawals at all.
Relationship
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If you are the spouse of the original IRA account holder, you are not required to take distributions. You may make additional contributions to the plan and you may treat the account as your own. Alternatively, you may roll the account over into an IRA you control. If you are not the spouse of the original IRA account holder, you must take distributions. Distributions are based on one of two methods. You must take all of the money from the account by December 31st following the fifth year of the account holder's death, or you must take lifetime distributions from the account based on your life expectancy outlined in the appendix of IRS Publication 590.
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Taxation
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The tax due on the account is based on the type of account you inherit. For IRAs, regardless of whether you are a spouse of the original account holder or not, you will pay income tax on all traditional IRA withdrawals. You will pay no tax on all Roth IRA withdrawals.
Misconceptions
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You may take distributions from an inherited IRA, even if you are a spouse and treating the IRA as your own, without paying a penalty for early distribution. This means that you won't be penalized for taking forced distributions if you are not the spouse of the original IRA account holder. But, it also provides you with an additional benefit if you are the spouse, since you get to control the IRA as if it were your own and make early withdrawals from the account.
Considerations
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If you are not the spouse of the original IRA account holder, and you want to use the inherited IRA to fund your own retirement, consider taking more than the amount required by the IRS up to the maximum contribution limit for your own retirement account. If the minimum required withdrawal from your inherited IRA is more than the maximum contribution limit for your retirement account, you'll obviously need to take the minimum amount. If you are forced to take more than the maximum contribution limit to fund your retirement account, consider funding a non-qualified retirement account like an annuity with the excess.
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