Generally speaking, an individual retirement account (IRA) is subject to inheritance tax if the owner of the account was age 59-1/2 or older at death, and an employer-sponsored pension, profit-sharing, or other form of retirement plan is taxable if the employee dies after retirement. This “tip” will provide the statutory and regulatory authority for those conclusions, and some of the exceptions to them.
Section 2111(r) of the Inheritance and Estate Tax Act, 72 P.S. § 9111(r), states that “Payments under pension, stock bonus, profit-sharing and other retirement plans, including H.R.10 plans, individual retirement accounts, individual retirement annuities and individual retirement bonds to distributees designated by the decedent or designated in accordance with the terms of the plan, are exempt from inheritance tax to the extent that the decedent before his death did not otherwise have the right to possess (including proprietary rights at termination of employment), enjoy, assign or anticipate the payment made.”
(Subsection (r) goes on to exempt from inheritance tax payments that would be exempt from federal estate tax, but that provision became a dead letter in 1978 when Congress amended section 2039 of the Internal Revenue Code to eliminate the exemption for retirement benefits paid in a form other than a lump sum subject to 10-year averaging. The fact that there is no federal estate tax because the decedent’s estate is less than the federal exclusion amount does not mean that retirement benefits are not subject to inheritance tax. See Woolslare Estate, 5 Fid.Rep.3d 363 (O.C. Allegh. 2015), aff’d, No. 1100 C.D. 2015 (Pa. Cmwlth. 2/19/2016) (unpublished).)
The meaning of “the right to possess …, enjoy, assign, or anticipate” is provided by the regulations in 61 Pa.Code § 93.131, and subsection (d)(2)(i)(A) provides that a right of withdrawal results in inheritance tax, but only if any penalty or additional tax is smaller than 10% of the withdrawal.
An IRA is controlled by the owner of the account, who can in theory withdraw all of the account at any time, but there is a penalty tax of 10% under section 72(t) of the Internal Revenue Code unless one of the exceptions applies, and one of the exceptions is that there is no 10% tax if the IRA owner is age 59-1/2 or older at the time of the distribution. So an IRA should not be subject to inheritance tax if the account owner is under age 59-1/2.
But there are other exceptions to § 72(t). Under § 72(t)(2)(A)(iii) the 10% tax also does not apply if the IRA account owner is “disabled” and “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration,” and under § 72(t)(2)(A)(iv) the 10% tax does not apply if the account owner is making substantially equal period payments from the account. An IRA is therefore subject to inheritance tax if either of those circumstances should apply.
Because an employee usually has no unilateral right to withdraw from an employer-sponsored pension, profit-sharing, or other form of retirement plan, and because federal law (ERISA) prohibits the assignment or alienation of those plan benefits by employees, the death benefits payable under those kinds of plans are generally not subject to inheritance tax before actual retirement and the start of benefit payments. See 61 Pa.Code § 93.131(d)(1)(iii) and (d)(2).