I just received an inheritance, and it is coming from an IRA. If I don't roll it into my own IRA and want the cash, do I have to pay taxes on it? If so, how much? Can I have taxes taken out up front, or do I have to pay at tax time?
An inheritance is typically not taxable to you as the beneficiary. However, beneficiaries of a traditional IRA will have to pay federal income taxes (and some states) on any funds withdrawn from an inherited IRA. The withdrawals are reported as income on your tax return with all other taxable income in the year of withdrawal. The tax amount depends on your income tax bracket in each year of withdrawal. Large withdrawals, such as may be the case if cashing in the entire inherited IRA, may drive your tax bracket or tax rates higher than if withdrawals were spread over several years.
The taxes are typically paid when filing your tax return, or in quarterly installments if you typically make quarterly tax payments. Most IRA custodians offer an option to have the taxes withheld from the withdrawal. You would have to instruct the custodian of the tax withholding amount or the custodian will offer a default withholding option of 20 percent. If the actual tax calculated when reporting the IRA withdrawal is higher than the 20 percent withheld, the difference will be due when filing your tax return. If the actual tax calculated is lower than the 20 percent withheld, a refund of the excess will be generated when filing the return.
Before deciding on cashing in the IRA, you should ask the IRA custodian what the options are. Unless you are a spouse, you do not have the option to roll the inherited IRA into your own. It will have its own distribution requirements depending on the age of the decedent and your relationship to the decedent. These are mandatory distribution rules the IRA custodian must follow.
Answered by: Thomas N. Alvaré, CPA, is managing principal with JFS Wealth Advisors in Doylestown, Pa.