05 Nov What taxes are due on an inherited IRA?
Q. My mother worked for the Board of Education in New York City. She contributed to her 403(b). When she passed away, the money was rolled over to an Inherited IRA for me as I was the sole beneficiary. She also had an IRA in New York. I am a New Jersey resident. When I receive an Required Minimum Distributions, do I have to pay New Jersey state tax?
A. We’re sorry to hear about your mother.
Before we get to the taxes, let’s review how these accounts should be treated.
As the designated beneficiary of your mother’s retirement accounts, the first step is to determine the tax nature of your mother’s accounts.
Because you did not indicate that your mother’s IRA or 403(b) accounts were “Roth” accounts and you had already rolled them into an inherited IRA, we’re going to assume both were traditional retirement accounts.
“This means that your mother did not pay tax on the dollars she contributed to either account,” said Adam Sandler, an attorney with Einhorn Harris in Denville. “Since your mother was a New York resident, the contributions that she made to her 403(b) were with pre-tax dollars for both federal and New York income tax purposes.”
You have already accomplished the next step, which is to establish a new inherited IRA account at a financial institution of your choosing and properly transfer the funds from your mother’s accounts into the inherited IRA, Sandler said.
He said it’s vital that such transfer is an “account to account” transfer.
“Unlike your own retirement accounts, as the beneficiary of a retirement account, you are not permitted to withdraw the funds and deposit them into the new inherited IRA,” he said. “Such a withdrawal is deemed a distribution and would be included in your income for the tax year.”
Each year, you are required to determine your Required Minimum Distribution (RMD) and must withdraw this amount from the account.
Withdrawing the RMD for an Inherited IRA begins in the year following your mother’s death, Sandler said.
“As the designated beneficiary of your mother’s retirement accounts, you are eligible to `stretch’ these distributions over your life expectancy,” he said. “To calculate the RMD, divide the year-end account balance by your life expectancy factor as published by the IRS.”
You can find that in IRS Publication 590.
Sandler offered this example. Assume your mother died in 2018 and the value of the inherited IRA on Dec. 31, 2018 was $100,000. If you turned 50 in 2019, then your life expectancy factor is 34.2 based upon the IRS table. The 2019 RMD would be $2,924 ($100,000 ÷ 34.2). For your 2020 RMD, assume the value of the Inherited IRA is $102,500 as of Dec. 31, 2019. Instead of referring back to the IRS life expectancy table, you simply subtract 1 from the prior year’s life expectancy factor. Therefore, the 2020 RMD would be $3,087 ($102,500 ÷ 33.2).
This process is repeated every year until the Inherited IRA is completely distributed, Sandler said.
One caveat is whether your mother was required to withdraw the RMDs during her life.
“Assuming she was retired, this would begin in the year she turned 70 ½,” Sandler said. “If that was the case, then assuming your mother died 2018, you would be required to withdraw her 2018 RMD less any withdrawals she actually took before her death.”
In 2019, you begin taking RMDs based upon your life expectancy as outlined above.
Finally, for each tax year, you will receive a 1099-R from the financial intuition where your inherited IRA is held, Sandler said.
The 1099-R will indicate the amounts withdrawn from the inherited IRA that must be reported on your federal and state tax returns.
“As a New Jersey resident, you will not be required to file a New York income tax return simply based upon the inherited IRA withdrawals,” he said. “Even if your mother was a resident of a state other than New Jersey or her IRA account was held in a state other than New Jersey, the withdrawals from your inherited IRA are taxable to you and you will pay state tax based upon your marginal tax rates.”
However, he said, this analysis would be different if a 403(b) participant was a New Jersey resident who already paid New Jersey income tax on his or contributions.
Although not applicable to your question, Sandler said, you should note that when a New Jersey resident makes a contribution to a 403(b) plan, such contributions are made with pre-tax dollars for federal income tax purposes, but after-tax dollars for New Jersey income tax purposes. Therefore, New Jersey residents pay New Jersey income tax on those contributions. When New Jersey residents take future distributions from the 403(b) account, such distributions are then taxed differently for New Jersey income tax purposes than federal income tax purposes, Sandler said.
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This story was originally published on Nov. 5, 2019.
NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.