How Do I Report an Inherited Roth IRA Distribution?

Due to recent tax code updates, there are unique regulations regarding inherited IRAs.

Inheriting an IRA can be complex. To ensure you make informed decisions, it’s wise to seek advice from an expert in this field.

Dependent upon your relationship to the deceased IRA owner, RMDs or distribution within 10 years could be required of you.

Taxes

As inheriting an IRA can have various tax ramifications, it is wise to consult a financial advisor in order to better understand your options.

The IRS provides detailed rules regarding IRA distributions, but doesn’t offer guidance in every situation. Your first step should be contacting your IRA custodian for more details about what should happen with your specific plan.

Once you have this information, the next step should be deciding how best to distribute it. Your distribution options depend on your relationship to the original account owner; spouses qualify as eligible designated beneficiaries and can treat their IRA like it belongs solely to them, which allows for longer RMD payouts that could reduce overall tax liabilities. Children (defined as son, daughter, stepson or stepsdaughter of original account holder) as well as disabled and chronically ill individuals can take RMDs according to their life expectancies, thus further lowering overall tax liabilities.

Reporting

An inherited Roth account must be reported on your income tax return just like any other retirement account would. If the original owner didn’t take their Required Minimum Distribution (RMD), by April 1 of the next year you must begin taking them yourself using IRS Publication 590-B’s single life expectancy factor to determine your required distribution amount.

If the deceased did not take an RMD in the year of death, you must empty their IRA within ten years. Withdrawals should either be equal each year, or larger when your income drops significantly. When withdrawing funds from a Roth IRA that you inherited within five years will be subject to income tax and potentially penalty; those made up entirely of pre-tax contributions do not fall under this rule and withdrawals taxed as ordinary income.

Withdrawals

Dependent upon who owns and manages the original account, various strategies may be available to you when withdrawing IRA earnings tax-free. For instance, if the account belongs to both of you working, one spouse could bypass RMD requirements altogether for tax-free withdrawals on earnings.

But if you are not the spouse of the deceased, RMDs must be taken at least annually starting the year following death and according to your own life expectancy. You may also choose to roll over any inherited IRA into one that already exists to avoid taxes; just make sure that meeting with an advisor first.

Alternately, you may decide to withdraw all of the assets held within an IRA entirely. This may be beneficial if the amount of Required Minimum Distributions that must be taken in subsequent years exceeds its value; or if higher tax rates may impact future IRA investments negatively.

Rollovers

When inheriting an IRA, you have two options for its treatment – treating it as your own and naming yourself as owner; or rolling it over into your existing traditional or Roth IRA via trustee-to-trustee transfer of accounts or custodians.

Spouses may take advantage of another option available to them when inheriting an IRA: treating it as their own and taking required minimum distributions until age 70 1/2 (or withdrawing all of it over 10 years). This provides spouses with ample flexibility.

As the tax rules surrounding inherited IRAs can be complex, it is wise to consult with a financial professional for advice. They will be able to maximize your options while adhering to all relevant rules. You can learn more about your distribution options from an inherited IRA by reading our Inherited IRA Brochure which covers scenarios outside the SECURE Act.


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