IRA ADVICE – ED SLOTT– In a recent case, a non-spouse beneficiary learned that an inherited IRA is taxable and is not treated as a tax-free “inheritance.” He received a total distribution from his deceased Mom’s IRA and thought that the IRA was an inheritance and not taxable. Accordingly, he never even filed a tax return to show the withdrawal. He was wrong on both points and had to pay the back taxes plus IRS penalties for not filing his return.
While property, such as a home or shares of stock, received as an inheritance after someone dies is generally tax-free, distributions from inherited IRAs to beneficiaries are taxable.
An inherited IRA is a Traditional, SEP or SIMPLE IRA that is established for a non-spouse beneficiary after the IRA owner dies. The IRA must be retitled after the IRA owner’s death in both the name of the decedent and the non-spouse beneficiary. For example, John Smith, deceased IRA fbo (for benefit of) Jane Doe.
Distributions from inherited IRAs are taxed as ordinary income when the beneficiary receives a withdrawal. If the withdrawals happen gradually over a period of years, such as when only required distributions are taken each year, then taxes are owed gradually. However, if the beneficiary receives a lump-sum distribution, then the withdrawal would be taxed all at once. Beneficiaries can NEVER do a 60-day rollover of a distribution that is payable to them. If they want to move the funds to another custodian or investment, the funds can only be moved as a direct transfer.
The IRS considers distributions from inherited IRAs to be death distributions that are taxable, but not subject to an early distribution penalty. The 10% early distribution penalty does not apply regardless of the IRA owner’s age when he died or the beneficiary’s age when the withdrawal is received.
Distributions from inherited Roth IRAs are tax-free if the account was held for at least five years including the time the Roth IRA owner had it.
Consulting with an expert in this area could save you from making what we call a fatal error – a mistake that cannot be corrected. You can find a list of Ed Slott trained advisors on our website, www.irahelp.com