If you are the beneficiary of a Traditional IRA account there are a few rules you need to be aware of.
If the person who owned the account at the time of their death was someone you did not marry and they were at least 10 years older or younger than you, here are a few rules to keep track of when determining how much money to withdraw:
1. The funds in the IRA account must be distributed to you in 10 years or less.
2. Each year you can choose to take a distribution, or you can keep the money in the IRA where it grows income tax-free. What this means is you are not required to take a “required minimum distribution” (RMD) from the account.
3. When you reach the last day of the 10 year period, all of the money in the IRA must be withdrawn. Any assets that remain are subject to a 50% penalty payable to Uncle Sam.
When deciding what to do remember that the money that is held in the Inherited Traditional IRA account is not subject to capital gains or ordinary income tax. But, when you receive your withdrawal from the account, anything withdrawn is attributable to you as ordinary income and taxed at your ordinary-income tax rate.
Now, what if the account was a ROTH IRA? The same rules apply – 10 years to distribute, no RMD, 50% penalty on the remaining funds – but the key advantage of an Inherited Roth IRA is the beneficiary does not owe taxes on any withdrawals from the account.
So long as the money is in either a Traditional or a Roth IRA it grows tax-free. The key difference is whether you owe income taxes on the withdrawal or not. So take that into account when determining whether to make a withdrawal.
For Inherited Traditional IRA’s it may make more sense to smooth out the withdrawals and take a similar sized withdrawal each year. If you wait until year 10 to make the withdrawal though the money has grown tax-free, the withdrawal of a large lump sum may place you in a higher tax bracket reducing some of your gains due to the income taxes owed on the funds received. For an Inherited Roth IRA, it may make more sense to keep the money in the account for the full 10 years to allow it to grow tax-free, and then withdraw the entirety of the account and enjoy a tax-free windfall.