Q&A: Taxes on retirement plan withdrawals

November 7, 2008

My grandfather recently died, and I received $300,000 from his retirement plan. I know his estate is required to pay tax on the proceeds, but must I pay income tax when I take money out of the plan?

Q: My grandfather recently died, and I received $300,000 from his retirement plan. I know his estate is required to pay tax on the proceeds, but must I pay income tax when I take money out of the plan?

A: All pre-tax money coming out of a retirement plan, whether it is yours or was inherited, is subject to ordinary income tax upon withdrawal. There is no step up in basis relating to retirement plan assets inherited because of death. In addition to the estate paying a tax, the recipient pays ordinary income tax as the money is withdrawn. However, where the estate has paid federal estate taxes (which generally apply only to estates valued at $2 million or more), you are permitted to take a tax credit that offsets your income tax at the time you withdraw money. Some accountants miss this deduction because they do not know whether the decedent paid the federal estate tax, so it is important that you document the tax paid so you can enjoy the deduction as you withdraw funds. One other point: Since the money you inherited was not a retirement plan from your spouse, you cannot roll it over. You must immediately start taking distributions.