Tax Liability of Your IRA Beneficiary

If you leave your Individual Retirement Account to a designated beneficiary, in most cases the beneficiary will have no tax liability. However, to do this the beneficiary must follow Internal Revenue Service regulations regarding inherited IRAs. Accounts left to heirs or beneficiaries through a designated beneficiary form avoid going through the probate process.

Roth and Traditional IRAs

Although Roth and traditional IRAs have different rules regarding withdrawals and taxes for the original account holders, the tax liability for beneficiaries of inherited IRAs are very similar. If the decedent held a traditional IRA, and was over age 70 1/2 at the age of death, make sure the estate takes the required minimum distribution before any changes in titling to the IRA.

Types of Beneficiaries

Spouses inheriting IRAs may roll it into a new or existing IRA within 60 days of receiving the inheritance. Spouses may also roll the amount over into a qualified employer retirement or annuity plan. Taxes are then based on the spouse's own withdrawals and tax bracket if held in a traditional IRA or employer plan. Only a spouse can treat an inherited IRA in this manner. According to the IRS, non-spousal beneficiaries may make trustee-to-trustee transfers, if the IRA into which it is transferred is set up and maintained in the name of the deceased IRA owner for the benefit of the beneficiary.

Five-Year Rule for Roth IRAs

For inherited Roth IRAs in which the beneficiary did not chose to roll it over into an IRA or make trustee-to-trustee transfers, all of the assets must be distributed by December 31 of the fifth calendar year after the decedent's death -- if the decedent died before the age of 70 1/2. Under this IRS regulation, the beneficiary may withdraw funds from the Roth IRA at any time, and in any amount by the end of the fifth anniversary. If the funding is depleted within this time frame, there is no tax liability for minimum required distributions.

Minimum Required Distribution

To avoid tax penalties as high as 50 percent, make sure you meet all minimum required distribution regulations for the inherited IRA. Otherwise, the IRS may take up to half of the amount that should have been withdrawn, but was not. The minimum required distribution for an inherited IRA retitled in the heir's name is based on the beneficiary's life expectancy, not that of the decedent IRA owner.