Taxes or Penalties on Withdrawal From a Beneficiary IRA

You must include all beneficiary IRA distributions on your tax return.

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Inheriting an individual retirement account is small consolation for losing a loved one. If you're not careful with your withdrawals, you could end up paying more than you need to in income taxes and penalties. If you're the surviving spouse and sole beneficiary, you have the option of treating the inherited IRA as your own. If so, the account is treated as if though you had always owned it, and the beneficiary rules do not apply.

No Early Withdrawal Penalties

Distributions taken by beneficiaries are never subject to an early-withdrawal penalty, because they are exempted. This applies no matter how old the decedent was at the time of death, and no matter how old the beneficiary.

Traditional IRA Income Taxes

When you inherit a traditional IRA, you also inherit the value of the nondeductible contributions made by the decedent, also known as the account's basis. The basis matters, because the portion of the distributions that come out of the basis are tax-free. For example, if you inherit a traditional IRA with a basis of $24,000, and when you take a distribution the value is $100,000, 24 percent of your distribution is tax-free. If you don't have a basis, the entire withdrawal is taxed. Either way, the taxable portion counts as ordinary income.

Roth IRA Income Taxes

If the death came at least five years after between the start of the year that the decedent made the first Roth IRA contribution, all distributions from the Roth IRA come out tax-free. For example, if the decedent made the first Roth IRA contribution during the 2010 tax year, all distributions would be tax-free if he died on Jan. 1, 2015 or later. If five years hadn't passed, the contributions would come out tax-free, but the earnings would be taxed when they were withdrawn.

Failure to Withdraw Penalties

When you inherit an IRA, you must take minimum withdrawals. If you don't withdraw the required amounts, you'll owe a 50 percent tax penalty. For example, if you were supposed to take out $23,000 but didn't, you'd owe a $11,500 tax penalty. The rules for when these withdrawals must be taken, and the amount, depend on the circumstances. In most cases, the default is that you must empty the IRA by the end of the fifth year after the decedent's death, but the beneficiary can usually elect to take annual distributions over the beneficiary's life expectancy. For example, if the decedent dies in 2013, the default would be that you have to empty the IRA by Dec. 31, 2018, but no withdrawals are required before that date. However, the beneficiary could also elect to spread those distributions over the rest of his life expectancy. Different rules might apply if the decedent's estate, rather than the person receiving the payments, is listed as the beneficiary.