Retirement - Question 58

What would happen to my IRA (Individual Retirement Account) if I died before 1 cashed it in? What about taxes?

After your death, your beneficiary will have several choices for receiving the proceeds from your IRA. The 10% penalty tax doesn't apply to these distributions, regardless of your age or your beneficiary's age. The distribution is subject, however, to income taxes (except for amounts that represent a return of nondeductible contributions). Thus, how your beneficiary elects to receive the proceeds can have a significant effect on the tax bill.

For example, if you had already started taking the required distributions because you were over age 70-112, your beneficiary could continue to take periodic distributions on the same schedule. If distributions had not yet begun, the relationship of the beneficiary to the owner will determine how the funds can be withdrawn.

The greatest number of options is available to surviving spouses. Your spouse can cash in all or part of the IRA without paying the 10% penalty. Or your spouse can roll over the IRA to his/her own IRA, making the money subject to the same rules as their own IRA. (Thus he or she would pay a 10% penalty tax if the funds were withdrawn before the age of 59 - ½ and withdrawals must start by age 70 – 1/2.) Another option is to allow the funds to remain in your IRA. The funds can remain in your IRA until the year you would have turned 70-1/2, at which time your spouse would have to start taking distributions based upon his or her life expectancy.

If your beneficiary is not your spouse, he or she has two basic options. Either funds can be withdrawn from the IRA within five years, or the beneficiary can start to take withdrawals within one year of your death (based upon his or her life expectancy). It is important that you name a beneficiary for your IRA in order to make these options available to your heirs. If you don't have a beneficiary and someone inherits your IRA under a will, their only option is to cash in the entire balance in the IRA within five years.