How are taxes handled on an IRA if you die before you make all the withdrawls? Does one pay income tax on the entire amount all at once? I vaguely recall that the estate pays estate taxes on the entire pre-tax amount, thence has to pay income taxes on the distribution.
The value of the IRA is part of the federal taxable estate.
And the beneficiary of the IRA recognizes income when the IRA funds are distributed. The distribution rules depend on whether the beneficiary is the spouse or not, and on whether the decedent had reached minimum distribution date.
For a Traditional IRA, there is a risk of double taxation (federal estate taxes paid by the estate and income taxes paid by the beneficiary). More below.
Credit to Mark Freeland who recently pointed out the following at misc.invest.financial-plan:
A non-spousal Traditional IRA beneficiary has the option of taking a lump sum distribution of an inherited, Trad IRA. If the total (which will include any IRAs) of the estate meets the threshhold for the federal estate tax, then the beneficiary may deduct the federal estate taxes on federal Schedule A.
For citations, see
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Some things to consider when deciding whether to take a lump sum distribution:
-- Does it land the beneficiary in a higher tax bracket, even after deducting any federal estate tax?
-- Is the beneficiary okay with taking the lump sum distribution and losing tax-deferred growth?
The estate taxes ATTRIBUTABLE to the IRA, as computed under IRC 691(c). That is NOT necessarily the same as all of the estate tax imposed (after credits).
Furthermore, if the IRA distribution is spread over a period (i.e. years), then the estate tax is also spread.
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And does the beneficiary have a significant choice? When limited to full distribution within 5 years, there may not be much of a difference.
Okay, I was a bit vague in the word "may" - I meant "may be able to", and not "is allowed to" (which is why I referenced Pub 559, p. 11 in my original post - that explains the section of the code you cited, in moderately plain English).
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