Taking Care of Mom and Dad: Are Distributions Taxable?
In general, distributions from a traditional IRA are taxable in the year your parents receive them. However, there are some exceptions to this rule. Distributions may be tax-free or only partly taxable if the retirement accounts include nondeductible contributions.
If your parents made after-tax contributions to any of their retirement accounts, they will have a cost basis (investment in the contract) equal to the amount of those contributions. These after-tax contributions are not taxed when they are distributed to your parents. They are a return of your parents' investment in their plans.
Only the part of the distribution that represents after-tax contributions (the cost basis) is tax free. If after-tax contributions have been made, distributions consist partly of those contributions and partly of pre-tax contributions, earnings and gains. Until an amount equal to all of your parents' cost basis has been distributed, each distribution is partly nontaxable and partly taxable.
Roth IRAs follow different tax rules. Because contributions to these accounts are made after taxes are paid, distributions from them -- including investment earnings on contributions -- are tax free, if withdrawn under rules I described earlier.
That also means that the rules about minimum distributions don't apply to Roth IRAs (although special tax rules do apply upon the death of the Roth IRA owner).
Calculating a minimum required contribution each year isn't difficult -- but it may be more than your parents want to do. Some older people avoid the process by moving their funds into an independent retirement annuity that's exempt from minimum distribution requirements. But this can be a costly way to avoid some simple math.
I'll examine the mechanical details of retirement annuities when I consider life insurance in Chapter 7. But, for now, I'll note that combining various defined contribution accounts into a single IRA that takes the form of an annuity is the closest thing there is to retirement money on "autopilot."
