Talk:Inheriting an IRA

From Bogleheads

Could you add a non-legalese explanation to the section on estate tax deductions, or a link to an IRS document? I believe what it means is that if a traditional IRA was included in a taxed estate, and you take a $5000 distribution from the IRA, you pay income tax on the $5000 but you may receive a credit in some amount against the estate tax that was already paid. If this is the case, it may make a traditional and Roth IRA be a wash for inheritance purposes. Grabiner 04:01, 5 August 2008 (UTC)

Not, Bob, but I did find a plain language quote explaining the deduction. Also check out Ed Slott's article How the IRS helps IRAs . The deduction may make the estate tax imposition on an inherited Traditional IRA and Roth IRA neutral, but remember that the beneficiary's subsequent RMD's from the Roth IRA will be tax free to the beneficiary, while tax will be owed on the RMD's from the Traditional IRA. Blbarnitz 13:39, 5 August 2008 (UTC)

The part Barry added is definitely a bit easier to follow. The part I added is pretty much straight out of the IRS publication, which is probably why it's a bit dense. But certainly don't worry about the fact that I slapped that part up there. It's a wiki. If it stinks, feel free to re-word it or just delete it altogether. I just put that bit of info up to get the ball rolling :) --CyberBob 16:40, 5 August 2008 (UTC)

Thanks for the clarification, and this does confirm that it is a wash, because the IRS rule is designed to make the conversion fair and avoid tax being paid on tax. In the posted example, if you are in a 25% tax bracket, you could either inherit $50,000 from the traditional IRA or $37,500 from a Roth if it had been converted. The estate tax on the Roth would have been $15,375, leaving you $22,125 after tax. The estate tax on the traditional IRA was $20,500, but you deduct that $20,500 from your taxable income, paying $7,375 tax on the remaining $29,500 and leaving you $22,125 after tax.Grabiner 04:20, 6 August 2008 (UTC)

The IRD deduction reduces the advantage of conversion but doesn't eliminate it. (In any case, it probably predates the Roth IRA by at least 50 years, so I don't think we can say that it's designed to make conversion fair.) Let's say that the estate tax ends up being 0% on the first $5 million and 50% on the excess, and say that the income tax is a flat 25% (as usual, if the beneficiaries will be in a lower income tax bracket, then that's a strong reason not to convert). Say that you're on your deathbed, deciding whether to convert. Your assets are $6 million in cash and $100,000 in a traditional IRA. Assume that your beneficiary will withdraw everything immediately (to eliminate the Roth advantage of a larger tax-sheltered balance). If you convert, you (or your personal administrator) will pay $25,000 in income tax for the conversion, leaving a gross estate of $6,075,000; estate tax will be $537,500; your (nonspouse) heir gets $5,537,500 free and clear; there is no IRD and so no deduction. If you don't convert, you have $6,100,000 in your estate, your estate tax is 50% of $1.1 million = $550,000; your heir gets $5,450,000 in cash plus the $100,000 traditional IRA; when he withdraws, he has $100,000 of income before the deduction. The deduction will be, basically, the share of the $550,000 estate tax that's attributable to this IRD, that is, $550,000 * $100,000 / $6,100,000 = $9,016.39. So the beneficiary pays 25% * ($100,000 - $9016.39) = $22,745.90, leaving him with $5,527,254.10, or $10,245.90 less than if you had converted.--LH2004 19:47, 1 September 2008 (UTC)