Inherited IRA's - The Tax-Man is Waiting

Joseph A. Lux, C.P.A., PLLC

June 1, 2019

With the recent passing of my Father-in-law I was personally reminded of the importance of planning for the inheritance of an Individual Retirement Account (IRA). Without proper planning, federal and state taxes can take a sizable bite out of the proceeds. The IRS has special rules that must be followed.

There are several options for non-spouse recipients of inherited traditional IRA’s, depending on the decedent’s age. (This column does not address spousal IRA’s. A spouse who inherits an IRA can treat it as his or her own.) An account owner of age 70½ is required to begin receiving minimum distributions (RMD’s) from the account by April 1 of the year after he reaches age 70½ (the required beginning date). If the decedent had already passed the required beginning date, there are just two choices for the IRA beneficiaries:
1. Taking a lump-sum distribution of the entire balance; or
2. Rolling the inherited IRA over into a new account and taking distributions over the longer of the life expectancy of the beneficiary or the decedent.

If the accountant owner died before reaching the required beginning date, or the IRA was a Roth IRA, the beneficiary has a third option of withdrawing all of the funds in the IRA account within five years of the decedent’s death. In addition, under the second option above, the life expectancy of the beneficiary must be used.

Here are some tips to consider:
1. Divorce, marriage, and the birth of children can all change estate plans. At death, IRA’s are passed by beneficiary designation, not by the decedent’s will. If the will says “I leave everything to my wife”, but the IRA account beneficiary is someone else, the IRA generally goes to whoever is the beneficiary on the IRA paperwork.

2. An inherited IRA must be titled with both the name of the decedent and beneficiary and must indicate that it is an inherited IRA by using words such as ‘inherited’ or ‘beneficiary.’ If you simply transfer the IRA balance to the beneficiary’s IRA, or a new account in the name of the beneficiary only, this will cause it to be treated as a distribution of the entire balance and it will be fully taxable in that year. Ouch!

3. Be sure to make the decedent’s RMD before the end of the year of death or else there’s a 50% penalty. And you still have to take the distribution and pay the tax.

4. Consider the impact of future tax increases. Even if taking a full distribution at once, or over five years, means a substantial tax bill now, it may well save taxes in the long run if tax rates increase in the future.

Meet with your CPA to discuss all options as they relate to your personal tax situation. Your CPA can help you to avoid costly tax traps that can be associated with an inherited IRA.

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