IRA Tax Treatment for Beneficiaries

Tax rules can be puzzling.

Internal Revenue Service (IRS) Publication 590 details the tax consequences of distributions from Individual Retirement Arrangements (IRAs). IRA beneficiaries have options to receive proceeds in different manners. Timing of distributions affects taxation.

Types

The two types of IRAs are raditional IRAs and Roth IRAs. Contributions to traditional IRAs are tax deductible; distributions from these accounts are taxable. Contributions to Roth IRAs are not tax deductible and distributions from Roth IRAs are not subject to taxation.

Considerations

A spousal beneficiary can maintain the tax deferred status of an inherited IRA, postponing taxation. This option is not available to non-spousal beneficiaries.

Effects

Traditional IRAs may have non-deductible contributions as well as deductible. Return on non-deductible contributions is not taxable. The portion of a withdrawal considered the return of non-deductible contribution is determined on a pro-rata basis.

Time Frame

A beneficiary can elect to take distributions from an inherited IRA across up to five years. Postponing distributions postpones taxation. You may take distributions in any form during the five-year period; they do not need to be equal amounts. Distributions can also be taken based on life expectancy.

Treatment

Distributions are taxed as ordinary income. You should receive a Form 1099-R detailing the distribution amount. Distributions to beneficiaries are not subject to the early distribution penalty for distributions taken before age 59½.

Warning

Any Required Minimum Distributions (RMDs) must be taken from the IRA before transfer to the beneficiary.

References

• Internal Revenue Service: Publication 590; publications and notices
• IRS Tax Topic 451: Individual Retirement Arrangements

Resources

• Motley fool: An inherited IRA