Who Pays Taxes on IRA Distributions?
An IRA is a tax-deferred investment account; however, when withdrawing funds they’ll incur income taxes.
Except when designated beneficiaries qualify (i.e. a spouse, chronically ill individual, disabled person or person more than 10 years younger than the original account owner). They can “stretch out” distributions over their lifetimes.
Spouse
The government offers tax breaks for saving in retirement accounts, but also needs its share when funds are eventually withdrawn from those accounts. That is why original account holders are required to start taking minimum distributions or RMDs beginning at age 72 – while heir rules differ slightly and tax rates depend on which beneficiary type receives those funds.
Spouses. Spouses generally have more latitude when it comes to handling an inherited IRA than nonspouse beneficiaries do in terms of dealing with their inheritance, and can take steps such as treat it like their own and possibly rollover to a Roth IRA. Nonspouse beneficiaries, on the other hand, must adhere to specific timelines in order to avoid taxes and potentially tax-deferred growth opportunities.
Spouses and nonspouses. If the deceased IRA owner was married, his or her spouse must withdraw RMDs by December 31 of every year regardless of whether he or she is still alive; if not yet aged 73, however, distribution can be deferred until April 1. Under IRS regulations requiring minimum withdrawals annually after age 73 has been reached but can opt to withdraw more than required without incurring penalty charges.
Dependent upon your circumstances, taking smaller withdrawals over a longer time frame could help reduce your taxes and potentially save on penalties. The IRS refers to this strategy as “stretching” an IRA; you can learn more in Publication 590-B: Distributions from Individual Retirement Arrangements.
Nonspouses who inherit an IRA must begin taking RMDs within 10 years from the death of its original account owner, with some exceptions for people who are chronically ill, disabled, or underage. As part of the SECURE Act passed in 2020, most heirs now must withdraw all assets within 10 years from an inherited IRA.
What Is Considered a Qualified Charitable Distribution? While an IRA allows donors to make charitable donations, certain criteria must be fulfilled for your gift to qualify as tax deductible. According to the IRS, qualified charitable distribution is defined as any otherwise taxable distribution made directly to a charity from an IRA account. There may be restrictions as to which types of organizations qualify as qualified distributions – you can find more details in Publication 590-B.
Nonspouses do not receive bankruptcy protection for inherited IRAs; the US Supreme Court held in 2005 that trusts containing them are subject to creditors in bankruptcy proceedings unless state law specifically says otherwise. A spouse in bankruptcy proceedings can have equal protection with his or her regular financial accounts; having up-to-date beneficiary designations on all your IRA accounts can help avoid issues associated with inheritance rights – it’s wise to review and update them after important life events such as marriage, divorce or death and remembering that beneficiary assignments supercede the terms of wills!
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