How to Dissolve an Inherited IRA

By Michael Keenan

An IRA is a qualified retirement account that receives special tax treatment. If a person dies with money still in the account, the IRA passes on to the beneficiary of the account. As a beneficiary, you generally have to withdraw all of the money within no more than five years or take minimum distributions annually for the rest of your life. However, a spouse can elect to treat the IRA as his own. You always have the option to dissolve the IRA, that is, take a distribution of the entire account, as soon as you inherit it. When you do so, you need to know how to report it on your income taxes as well as what the tax implication might be.

An IRA is a qualified retirement account that receives special tax treatment. If a person dies with money still in the account, the IRA passes on to the beneficiary of the account. As a beneficiary, you generally have to withdraw all of the money within no more than five years or take minimum distributions annually for the rest of your life. However, a spouse can elect to treat the IRA as his own. You always have the option to dissolve the IRA, that is, take a distribution of the entire account, as soon as you inherit it. When you do so, you need to know how to report it on your income taxes as well as what the tax implication might be.

Step 1

Request IRA account information from the executor of the estate. You'll need to know whether the account is a traditional IRA or a Roth IRA, as well as which financial institution is the custodian of the IRA so that you can contact the custodian to get the forms you need to dissolve the account. If you have inherited a traditional IRA, find out if the decedent made any nondeductible contributions. If you inherit a Roth IRA that's been open less than five years at the time you plan to dissolve the account, you need to know the amount the decedent contributed to the Roth IRA.

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Step 2

Request a distribution in full from the financial institution that holds the IRA assets. At the end of the year, you will receive a Form 1099-R that shows the amount of the distribution. The taxable portion will appear in box 2a. If it is a traditional IRA, the entire amount will be taxable unless the decedent made nondeductible contributions to the IRA, which are uncommon. If it is a Roth IRA, the entire amount is tax-free as long as the decedent had the account open for at least five years. If not, only the amount attributable to contributions is tax free. Investment earnings are taxable.

Step 3

Report the amount of the distribution on your income taxes as a taxable IRA distribution. If you use Form 1040, it gets reported on line 15a. If you use Form 1040A, it gets reported on line 11a.

Step 4

Complete Form 5329 if your Form 1099-R has code 1 in box 7, so that you do not get charged the extra 10 percent early withdrawal penalty. Usually, the 1099-R will have code 4 in box 7, which signifies that you received the distribution as a beneficiary and are not subject to the penalty. However, if it has code 1, you need to complete Form 5329 to avoid the penalty. On Form 5329, enter the amount of the distribution in box 1, code 4 next to line 2, and the total amount of the distribution on line 2. This shows the IRS that the entire amount of the distribution was taken as a beneficiary and therefore is exempt from the early withdrawal penalty.

Step 5

Include any income taxes withheld from the dissolution of your IRA as part of the income taxes withheld for the year on your tax return. By default, 10 percent of the distribution is withheld for federal income taxes. However, you can elect to have more or less withheld if you complete Form W-4P. Any federal withholding amounts are reported in box 4 of the Form 1099-R. These are reported on line 62 of Form 1040 or line 36 of Form 1040A. Any state income taxes withheld are reported in box 12 and reported on the state tax return.

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What Is 1099 Inheritance?

References

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