Distributions from an inherited IRA/401k to a person resident in Germany

IRAs are commonly used in estate and tax planning throughout the U.S. Accordingly, many German residents entitled to an inheritance with a U.S. situs will find that such an inheritance will include an IRA. Most U.S. residents and/or citizens will choose to treat the IRA as their own or roll it into an existing IRA. This option is often unavailable or is unattractive for those with limited ties to the U.S. Once a German resident determines how to treat their inherited IRA, they will need to assess the tax repercussions in the U.S. and Germany. This assessment will necessary require analysis of the Germany-U.S. Treaty on Double Taxation.


What options have beneficiaries of an inherited IRA?

Beneficiaries of an inherited IRA must determine the most optimal treatment based on their relationship to the Decedent.  

Inherited IRA from Spouse 

A spouse who inherits an IRA has options available to them that are unavailable to non-spousal beneficiaries. A spouse may treat the inherited IRA as if it is their own by designating themselves as the account holder. A spouse who designates themselves as the account holder will be able to benefit from the traditional attributes of an IRA such as tax-free growth. However, these individuals will also be subject to the withdrawal rules that dictate that an individual must take required minimum distributions (RMDs). However, the RMDs will be based on the age of the surviving spouse. A spousal beneficiary may also “roll-over” the inherited IRA into a qualified plan such as a qualified employer plan and tax-sheltered annuity plan. Pragmatically, most German domiciled individuals will view these options as being unattractive. Many German domiciled individuals will not want to maintain an IRA in the U.S. Further, the majority of these individuals will not have a qualified plan for the IRA to be rolled into. Additionally, there are only a few U.S. financial institutions which offer financial services for nonresidents. For those individuals, they will likely seek to be treated as a beneficiary and seek a distribution of the assets. 

IRA Inherited from Non-Spouse 

An individual who inherits an IRA from a non-spouse will not have the option of treating the IRA as their own or rolling over the IRA. The non-spouse beneficiary will need to receive distributions under the rules applicable to IRA beneficiaries.

Taxation of the payment to the beneficiary 

3.

If the beneficiary demands a lump sum distribution, the total amount distributed will be subject to taxation in the U.S. as personal income. See IRC Sec. 102, 691. If an IRA is assumed or rolled over, the corpus will grow tax-free and U.S. income tax will only be incurred on the amounts distributed. As the U.S. income tax is progressive, the tax triggered by a lump sum distribution may subject the beneficiaries to the tax rate applicable to the highest tax bracket and the tax may be significant. Accordingly, many U.S. attorneys and accountants will advise beneficiaries to assume or roll-over the IRA. 

4.

In addition to federal income tax, a distribution from an inherited IRA can trigger federal estate tax and state inheritance tax. These taxes may be mitigated by the fact that many states do not have estate tax and the federal government provides for significant estate tax exemptions for the estate of U.S. citizens and residents. If applicable, income tax paid can be offset at least in part against the estate tax. If these exemptions are applied, taxation can be limited. Non-resident aliens will need to assess the applicable treaty benefits. 

5.

If the beneficiary of an IRA has his tax domicile in Germany, only Germany may impose income tax. See Art. 21 and Art. 18 of the German-American Income Tax Treaty. However, if the second beneficiary was a U.S. citizen, the U.S. may also tax the IRA distributions. See Art. 1 (4) and (5) of the German-American Income Tax Treaty (“Savings Clause”). 

6.

Germany may impose German inheritance Tax (Erbschaftsteuer) due to the fact that the beneficiary resides in Germany. See Art. 11 1. b) of the German-American Estate/Inheritance Tax Treaty. In this case, Germany levies inheritance tax pursuant to § 3 Abs. 3 Nr. 4  of the German Inheritance and Gift Tax Act (ErbStG). See decision of the German Federal Tax Court (Bundesfinanzhof) dated June 15, 2016 (file number: II R 51/14)). However, if the beneficiary is the surviving spouse of the Decedent or a dependent/minor offspring of the Decedent, we contend that it is arguable that transfers to these individuals would be tax exempt. 

7.

Whether, and to what extent, German income tax is incurred in addition to inheritance tax is a disputed issue. While some tax offices regard payments made before the entry into force of the protocol on the Double Taxation Agreement (Jan. 1, 2008) as trigging tax on the difference between incoming and outgoing payment, others believe that there is deferred taxation which is always applicable. We contend that only the difference between incoming and outgoing payment should be taxed as payments to an IRA would not be tax exempt under German tax laws and, thus, shouldn’t be taxed as a German tax deferred savings plan but as distributions from a (non-tax deferred) life insurance.

8. 

If German income tax and German inheritance tax is payable, a discharge is to be granted pursuant to § 35 b EStG

Jerome Synold
Jan-Hendrik Frank
Letzte Aktualisierung: 17.10.2013