If you have received an inheritance from one of your family members, you may be worried about the possibility of paying a tax on that inheritance. The inheritance tax does not apply to individual retirement accounts (IRAs) under certain circumstances. If you or a family member is concerned about Pennsylvania’s inheritance tax on IRAs, you should speak with an experienced Pennsylvania tax lawyer. At Herr Potts and Potts, our experienced lawyers are here to provide you with representation that will be tailored to your unique legal needs. The intricacies of tax law are difficult to navigate through, but we are here to help guide you through your tax matters. Our lawyers are here to explain when heirs must pay inheritance tax in Pennsylvania.

When Must Heirs Pay an Inheritance Tax on IRAs in Pennsylvania?

Individual retirement accounts allow an individual to save money for their retirement on a tax-free or tax-deferred basis. An IRA can be a valuable estate planning tool because the owner of an IRA can name a family member or other individual as a beneficiary of the IRA assets. Generally, there are three types of IRAs that an individual can possess:

  • Traditional IRA – Traditional IRAs are created using money that you can deduct from your tax return. The money you contribute to the account may grow on a tax-deferred basis until you withdraw it when you enter retirement. This IRA has a maximum for yearly contributions that is capped at $5,000; if over the age of 50 the IRA owner can contribute an additional $1,000 annually.
  • Roth IRA – Roth IRAs are created with currency that you have already paid taxes on. This means that your funds can grow tax-free and you may be able to make tax-free withdrawals from your IRA under certain circumstances. Roth IRAs also have an annual contribution limit of $5,000 and an additional $1,000 if the owner is over the age of
  • Rollover IRA – Rollover IRAs use money that that is “rolled over” from another retirement plan. This means that you can transfer money from an employer-sponsored retirement plan like a 401(k) or 403(b) to create a rollover IRA.

Whether an heir must pay an inheritance tax on an inherited IRA depends on the age of the IRA owner when they pass away and the individual who inherits the IRA. If an IRA owner passes away before they reach the age of 59 1/2, the IRA given to a beneficiary will not be subject to Pennsylvania’s inheritance tax. Therefore, if the decedent was over the age of 59 ½, the beneficiary must pay the inheritance tax. However, the inheritance tax rate will depend on the relationship the beneficiary had with the decedent.

If you wish to know more about inheriting an IRA or naming an individual as a beneficiary of an IRA, you should speak with an experienced Delaware County estate planning lawyer.

Pennsylvania Inheritance Tax Rates for IRAs

As mentioned above, your relationship with an IRA owner will determine the inheritance tax rate you must pay for being named as a beneficiary. Currently, the Pennsylvania inheritance tax rate is:

  • 5% for transfers made to direct descendants like children or grandchildren
  • 12% for distributions to siblings
  • 15% for transfers to non-spousal beneficiaries

There are also individuals and organizations that are exempt from the inheritance tax entirely. For example, surviving spouses and children under the age of 21 who receive an inheritance are exempt from the inheritance tax (children over 21 are subject to the 4.5% rate). Additionally, charitable organizations, government entities, and other institutions may be exempt from the inheritance tax.

Spouses who are the beneficiary of an IRA can also choose to transfer the IRA into their name or inherit the IRA. Fortunately, Pennsylvania chose to eliminate the “widow’s tax” that would cause a spouse to pay taxes on an IRA and other inheritances. This allows spouses to inherit marital property without enduring long processes like probate. However, non-married couples are not eligible for an exemption from Pennsylvania’s inheritance tax and will be charged at the 15% rate.

A child or unrelated beneficiary can choose to receive the IRA as a lump sum distribution or receive it as a beneficiary IRA. Even if the beneficiary does not elect to take a lump sum payment, they must still pay the inheritance tax on the full value of the inherited IRA.

West Chester Elder Law Attorneys Can Assist You with Inheritance Tax Issues

If you or a family member is worried about the inheritance tax for an inherited IRA, you should speak with an experienced West Chester elder law attorney. At Herr Potts and Potts, our attorneys have over eight decades of elder law experience that they will use to help you with your case. To schedule a confidential consultation, call us at (610) 254-0114 or reach us online.