This means that taxes are paid when the owner of an IRA account or the beneficiary, in the case of an inherited IRA account, receives distributions. IRA distributions are considered income and are therefore subject to applicable taxes. An inherited IRA may be taxable, depending on the type. If you inherit a Roth IRA, you’re tax-exempt.
With a traditional IRA, however, any amount you withdraw is subject to normal income tax. Beneficiaries don’t have to worry about the 10% early withdrawal penalty imposed by traditional IRAs. This is true regardless of the age of the IRA owner or beneficiary. However, distributions from an inherited traditional IRA
are taxable.
This is referred to as “income in relation to a deceased person.” This means that if the owner had paid taxes, the income is taxable for the beneficiary. It is important that the income tax treatment of the IRA remains the same from the original account to the inherited IRA. If the IRA owner died with a large fortune on which federal inheritance taxes were paid, you, as the beneficiary, are entitled to a tax deduction for the portion of those taxes that is attributed to the
IRA.
Any type of IRA can be converted to an inherited IRA, including traditional IRAs and Roth IRAs, SEP IRAs, and Simple IRAs. An IRA can be a valuable estate planning tool because the owner of an IRA can name a family member or someone else as the beneficiary of IRA assets. A child or an unrelated beneficiary can choose to receive the IRA as a lump sum distribution or as a beneficiary IRA. Spouses who are the beneficiary of an IRA may also choose to transfer the IRA to their name or inherit the IRA.
An inherited IRA is an individual retirement account that is opened when you inherit a tax-advantaged retirement plan (including an IRA or a retirement plan such as 401 (k)) after the owner dies. However, if the Roth IRA is from someone else, the beneficiary must take RMDs the same as if it were a traditional IRA. Whether an heir must pay inheritance tax on an inherited IRA depends on the age of the IRA owner when he dies and on the person who inherits the IRA. An inherited IRA tax administration tip is to avoid immediately withdrawing a single lump sum from the
IRA.
The original account holder of a Roth IRA is never required to accept RMDs, but those who inherit Roth IRAs do so unless they fall into one of the exemption categories.
