Tax Impacts of Being an IRA Beneficiary

An IRA is non-testamentary asset, meaning it’s not included in the “probate estate”.  Therefore, the assets in the IRA will go directly to your beneficiary and will not be affected by your will.  The IRA is included in the “taxable estate” however.  This will count towards figuring out the decedent’s federal estate tax

If your estate is valued under $5 million, it is exempt from the federal estate tax.  This is your entire estate, including your IRA.  But what about the implications of income tax on your traditional IRA plan, which is funded with pre-tax money.  During your lifetime, all withdrawals are subject to income tax.  When you pass away, your beneficiary will be responsible for the taxes on distributions.

When you pass on, your IRA beneficiary assumes your IRA fundsIf your beneficiary is your spouse, he/she can rollover the IRA into an IRA in your spouse’s name (whether it’s an existing plan or a new one).  He/she should immediately name a beneficiary in case of his/her death.  Upon your death, your spouse does not have to start making withdrawals.  He/she can treat it as if it was always his/her IRA.  At age 59 1/2, there are no early withdrawal penalties (but is counted as taxable income).  Once he/she reaches age 70 1/2, he/she must start making required minimum distributions (RMDs) and pay the taxes due.

If your beneficiary is not your spouse (say a child or grandchild), the rules are a bit different.  Here are the options for a non-spousal beneficiary:  First, they can withdraw the funds within five years and pay the income tax on it.  Next, the beneficiary can take RMDs based on his/her statistically determined life expectancy (which the IRS determines).  A younger person can benefit by spreading out the taxes due over a longer period of time.  If the decedent was older than you (say an older sibling), you can use his/her life expectancy when taking RMDs.  You would be making the distributions as if the original IRA owner was still alive.  Lastly, you could take the entire IRA as a lump sum payment (paying all the income taxes due of course).  The tax implications are high, but if you really need the money, the option is available to you.

In conclusion, be sure to name at least one beneficiary when opening up your IRA.  Also, keep it updated from year to year in case your situation changes.  Lastly, you should talk with your plan custodian to be aware of all the options available to you since not all plans offer all of the above options.  If you have any questions, contact the IRA experts at the IRA Financial Group today!

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