If a person dies with money left in his IRA, the funds in the account pass on to whomever the owner has named as a beneficiary. The beneficiary can liquidate the account or take withdrawals over his lifetime. It makes sense to name the youngest person possible as the beneficiary, to maximize the amount of time the money can grow tax-free, but the child is still responsible for any taxes due on the account.
If the child is the beneficiary of an inherited IRA that is a Roth account, all distributions from the account to the beneficiary are tax- and penalty-free. The contributions that the owner has made to the Roth account over the years have been made with after-tax money, and any distributions that the owner of the account would have taken would be tax-free as well. This tax-free benefit also passes to the beneficiary owner, regardless of his age.
Distributions from an inherited traditional IRA are taxable when the beneficiary withdraws the funds. The usual 10 percent tax penalty does not apply to these withdrawals, regardless of the age of the beneficiary. Investment income earned by a child may be taxed at the parent's higher tax rate, depending on the child's income. IRA income, on the other hand, is considered normal income and is taxed at the child's income tax rate.
The first $8,925 in income received by any taxpayer, including a child, is subject to a 10 percent income tax. The income earned between $8,926 to $36,250 is taxed at 15 percent, and income from $36,251 to $87,850 is taxed at 25 percent. This is assuming the filing status of the child beneficiary is single. IRA distributions and all earned income are taxed at these rates, based on the child's, and not the parent's, income.
Calculating Minimum Distribution
You figure the yearly minimum distributions from an inherited IRA, either Roth or traditional, based on the life expectancy of the beneficiary owner. For example, if the beneficiary of the IRA is 9 years old, his life expectancy is 73.8 years, according to IRS actuary tables. If the value of his inherited IRA is $500,000, he would have to withdraw a minimum of $6,776 that year, or the value of the IRA divided by the life expectancy. The beneficiary can withdraw more than the minimum at any time.
A child is required to file an income tax return depending on what his total income is for the year. Assuming the beneficiary-child owner of an IRA is claimed as a dependent on his parent's return, and single, he must file a tax return if his IRA distribution is more than $950. That minimum amount increases to $2,400 if the child is blind.
How to Report IRA Distributions
The trustee of the IRA will report the distribution to the beneficiary of the IRA on Form 1099-R. Box 1 will show the total amount of the distribution, with the taxable amount shown in box 2a. If the distribution is not taxable, no amount will be shown in that box. List the total distribution on Form 1040, line 15a, with the taxable amount listed on line 15b. On Form 1040A, show these amounts on lines 11a and 11b, respectively. You will calculate the amount of taxes by completing the form.
- Market Watch: The 10 Vital Rules for Inherited IRAs
- Internal Revenue Service: Tax Topic 553 -- Tax on a Child's Investment Income
- Internal Revenue Service: Publication 929 -- Tax Rules for Children and Dependents
- Internal Revenue Service: Instructions for Forms 1099-R and 5498
- Bankrate.com: Tax Brackets
- Internal Revenue Service: Form 1040 -- U.S. Individual Income Tax Return
- Internal Revenue Service: Form 1040A -- U.S. Individual Income Tax Return
- Internal Revenue Service: Publication 590 -- Individual Retirement Arrangements (IRAs)
Craig Woodman began writing professionally in 2007. Woodman's articles have been published in "Professional Distributor" magazine and in various online publications. He has written extensively on automotive issues, business, personal finance and recreational vehicles. Woodman is pursuing a Bachelor of Science in finance through online education.