Tax Consequences for the Beneficiary of a Decedent's IRA
Inheriting a traditional Individual Retirement Account is not necessarily tax-free. While you may receive some money tax-free, you may also receive a large tax bill. When your spouse or parent leaves you their IRA, you should understand the rules for taxation of this account as well as your obligations in regard to distributions so that you avoid unnecessary IRS penalties.
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Spouses
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A spouse inheriting a traditional IRA may elect to choose to keep the IRA and retitle it in her name. Otherwise, the spouse may elect to transfer the funds into an existing IRA she owns. She may make contributions to the account and treat the money as though it were her own. When making withdrawals, there is no 10-percent penalty for money withdrawn prior to age 59 1/2, and all withdrawals are subject to ordinary income tax. Spouses must start taking withdrawals by age 70 1/2 as they would otherwise be required to do.
Non-Spouses
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Non-spouses are not allowed to treat an inherited IRA as their own. Instead, you must withdraw the money as a lump sum, over a period of five years or over your lifetime. The money in the account is taxed at ordinary income tax rates when it is withdrawn. Money not withdrawn according to the withdrawal requirements is subject to a 50-percent penalty. This penalty is persistent every year until the correct amount of money is withdrawn.
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Benefit
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Even though the rules are somewhat more strict for non-spouses, inheriting an IRA under both circumstances allows for some flexibility. In both scenarios, you have the option to take money out as a lump sum, spread it out over a truncated time table or make lifetime withdrawals. This allows you to align a withdrawal strategy with your own personal financial goals.
Exception
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All IRAs are subject to ordinary income tax except one. A Roth IRA is not subject to any taxation as long as the account has been open for at least five years. Since the Roth inheritance is tax-free, it won't impact your other earned income and won't increase your tax liability in the same way a traditional IRA inheritance would.
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