South Carolina Insurance Practice Exam

Mike has inherited his father's traditional IRA. As beneficiary, he will pay ____ taxes on any money withdrawn?

1. Capital gains

2. Income taxes

3. Estate taxes

4. Gift taxes

The correct answer is: Income taxes

When Mike withdraws money from his inherited traditional IRA, he will be responsible for paying income taxes on those withdrawals. Traditional IRAs are funded with pre-tax dollars, meaning that taxes have not yet been paid on the contributions or the investment gains accumulated within the account. As a beneficiary, Mike will not incur capital gains taxes when he withdraws funds from the IRA; rather, the amount he takes out will be treated as ordinary income, which is subject to income tax. This distinction is important as it directly impacts how much Mike will owe when he begins to take distributions. Estate taxes are applicable to the overall value of an estate before distribution, but since Mike is a beneficiary and not the estate owner, he would not pay estate taxes directly on the IRA funds. Gift taxes pertain to transfers of assets during a person’s lifetime, which is not relevant in this context since Mike is inheriting the account rather than receiving it as a gift. Therefore, income taxes are the applicable taxes on withdrawals from his inherited traditional IRA.