Mistakes made with an inherited IRA can quickly become very expensive. A recent article in The Hampton Roads Business Journal, “You may be paying more tax on inherited IRA than required,” explains the basics.
During life and after death, IRAs are distributed differently than other assets. Your IRA beneficiaries may qualify for special tax breaks that are often overlooked. IRAs cannot change ownership during your life or be jointly owned, and generally pass by contract, not by a will.
IRAs may require their own estate plans, and those plans should be integrated within the overall estate plan. Speak with your estate planning attorney about tackling this.
As far as taxes are concerned, IRA investment gains may not be subject to the 3.8% investment income surtax and may be subject to double tax at death, both income tax and possibly estate tax.
For example, if you were to inherit an IRA from your father at his death and he has a taxable estate, as the beneficiary you may be entitled to a special deduction that can offset some of the otherwise-taxable distributions from that IRA. This deduction is easy to miss because of the two entities that must coordinate their tax planning: (1) the settling estate and (2) the IRA beneficiary. It is common for these two not to make a coordinated effort to realize all of the tax-saving opportunities.