Tax Questions for the Beneficiary of an IRA
When you inherit an IRA, you may have to pay tax on the proceeds you receive. This largely depends on your relationship to the original account owner. IRA proceeds need to be properly accounted for, and all IRS tax rules and regulations must be followed to avoid incurring any penalties.
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What kind of tax must I pay?
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An IRA is an Individual Retirement Account. When you inherit an IRA, you are not inheriting an investment, but rather an investment account. Think of an IRA as a sort of "umbrella" that shields investments from taxation. So, under the umbrella of an IRA, there may be stocks, bonds, annuities, bank CDs, stock options, precious metals or real estate. All of these investments must be liquidated and then withdrawn from the account. When they are, you must pay ordinary income tax on the investments. This is because the IRA eliminates the normal capital gains tax for these investments. Instead, withdrawals are considered to be investment income.
What are my options if I am the spouse of the account owner?
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If you are the spouse of an IRA account owner, you may choose to treat the IRA as your own IRA or you may roll the IRA into an IRA you own. Alternatively, you may cash out the IRA and pay income tax on the proceeds. If you elect to treat the IRA as your own, then you may make contributions to the account and you are subject to the IRA's required minimum withdrawal rules at age 70 1/2.
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What are my options if I am not the spouse of the account owner?
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If you are not the spouse of the original account owner, then you must withdraw the funds from the IRA in one of two ways. You may withdraw the complete account by Dec 31st of the fifth year after the account owner's death. Otherwise, you may take lifetime withdrawals from the account. The withdrawals from the IRA must not exceed your lifetime.
Do I pay a penalty for early withdrawal of funds?
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Normally, withdrawals from an IRA prior to age 59 1/2 are subject to a penalty, in the form of an excise tax, or 10 percent. This penalty does not apply to inherited funds. Instead, regardless of whether you are the spouse or not, you may take proceeds from the IRA without a 10 percent penalty if you are under age 59 1/2. This is true even in cases where you are the spouse and elect to treat the IRA as your own.
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