When you inherit most types of financial accounts, like savings accounts or checking accounts, you don’t have to worry about paying income taxes on the distributions. However, individual retirement accounts are treated differently by the federal tax code and you’re often responsible for paying taxes on the IRA after death. If you don’t know how your withdrawals will be taxed, you could find yourself owing a lot more than you expect when you file your taxes at the end of the year.
You pay taxes on an inherited traditional IRA at your marginal income tax rate. The more income you have, the higher your applicable tax rate.
Inherited IRA Rules
If you are inheriting an IRA from a parent, planning for taxes on the distributions is vital for budgeting what you can actually spend from the distributions. Withdrawals from traditional IRAs are treated as taxable income to you in the year that you take the money out. These withdrawals are taxed as ordinary income, so the tax rate applied to the distributions will be taxed at your marginal tax rate. For example, if you fall in the 24 percent tax bracket and you take out $5,000, your tax bill goes up by $1,200 because of your distributions.
Inherited Roth IRAs
The rules for an inherited Roth IRA are different than for traditional IRAs. If the owner of the IRA died after the account had been open for at least five years, and at least five years have elapsed since any conversions from a traditional IRA or other pre-tax qualified retirement account, any distributions from the Roth IRA will count as qualified distributions. That means that all of your withdrawals from the inherited Roth IRA will come out tax-free. If, however, those requirements aren’t met, the portion that doesn’t meet the requirements will be tax-free to the extent you withdraw contributions the decedent made, but when you withdraw earnings, those will be hit with income taxes.
2018 Tax Rates Lowered
The Tax Cuts and Jobs Act of 2017 lowered the income tax rates for the 2018 tax year, which means you’ll pay less on IRA distributions taken during the 2018 tax year. The lowest tax bracket is still 10 percent, but the subsequent brackets have been cut to 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and a top rate of 37 percent.
Higher Rates in 2017
In 2017, prior to the tax cuts, the individual tax rates were higher so even if you were taking out the same amount, you would pay more in taxes. Though the lowest tax bracket was still at 10 percent, the subsequent tax brackets were 15 percent, 25 percent, 28 percent, 33 percent, 35 percent and a top rate of 39.6 percent.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."