Inherited IRA – Income tax in Germany

In the US, tax-beneficial retirement plans can be inherited. This is not the case with comparable tax-beneficial company or private pension plans in Germany. Nevertheless, income from a US plan is taxable in Germany if the beneficiary is resident in Germany.

How is an inherited IRA established?

In principle, all tax-beneficial US retirement plans can be inherited. This applies to both company and government plans such as 401(k) plans, Roth 401(k) plans, 403(b) plans, and governmental plans, as well as IRAs and Roth IRAs.

If the beneficiary is not the surviving spouse, the beneficiary must continue the plan as an inherited IRA. The beneficiary cannot contribute to the plan and must withdraw all assets from both traditional and Roth IRAs within 10 years. If the deceased had already begun required minimum distributions (RMDs), these must be continued, with all assets being withdrawn within 10 years.

Surviving spouses have other options. For example, they can transfer the plan assets to an own plan.

What are the taxation rules in the US?

The taxation rules for withdrawals and permissible rollovers in the US are as follows. Withdrawals from traditional IRAs are subject to regular income tax. Withdrawals from Roth IRAs are subject to the special rule that withdrawals are only tax-free if the plan existed for at least 5 years prior to the decedent's  death.

What are the implications of the double taxation agreement between Germany and the US?

If the beneficiary is subject to unlimited tax liability in Germany, withdrawals must be taxed in Germany. If the beneficiary is a German citizen, the withdrawals are tax-free in the US. To avoid tax deduction in the US, Form W-8 BEN must be submitted to the relevant financial institution.

For beneficiaries with US citizenship, withdrawals must be reported on the US income tax return. Withdrawals from a Roth IRA are tax-free under the above described conditions. Withdrawals from a traditional IRA are taxable in the US. German income tax must be credited against US income tax. This also applies to persons with dual citizenship.

How is taxation handled in Germany?

Withdrawals from a traditional IRA are subject to full taxation in Germany. Payments from a Roth IRA are taxed at the difference between the withdrawals and attributable contributions made into the plan. If the beneficiary has reached the age of 60 or 62 and the contract has been in place for more than 12 years, only half of the difference is taxable.

For details, see here

Author: Peter Scheller, Tax adviser, Master of International Taxation

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