How Long Do You Have to Distribute an Inherited Roth IRA?
Dependent upon your situation, there are various strategies available to you for withdrawing from an inherited Roth IRA. However, you must transfer all assets to an inherited account and take required minimum distributions (RMDs) within 10 years after the original account owner passed away.
Surviving spouses, disabled and chronically ill individuals and trusts may opt to wait until the late partner reaches age 72 before beginning distributions, in order to avoid incurring early distribution penalties.
Life expectancy method
IRS rules mandate that owners of individual retirement accounts take withdrawals annually; these withdrawals are known as required minimum distributions (RMDs). This rule also applies to beneficiaries inheriting accounts; RMD calculations use a formula that takes into account each beneficiary’s relationship to the deceased owner and age when calculating RMDs; stretch IRA strategies can allow these inheritances to be distributed over their beneficiary’s lifetimes.
The SECURE Act altered how non-spouse beneficiaries receive Roth IRAs after their deaths, requiring heirs to empty it within 10 years after death unless one of several exceptions are met, such as being the surviving spouse, having minor children, chronically ill beneficiaries or those not more than 10 years younger than original account holder.
The 10-year rule does not apply to pre-tax Traditional or non-Roth IRAs inherited after tax, although it does apply to employer sponsored retirement accounts such as 401(k).
Ten-year method
Beneficiaries who inherit an IRA face various choices when inheriting it, which may have an impact on both tax burden and other sources of income. With 2019’s SECURE Act upending longstanding rules, beneficiaries have more complex decisions to make than ever.
Eligible designated beneficiaries (including minor children, disabled adults, chronically ill individuals and properly-drafted “see-through” trusts) have two options for choosing how their inheritance accounts should be distributed; either using the life expectancy method or 10-year rule. Starting in 2020 most inherited IRAs must use this option while the latter rule applies to all such accounts beginning 2021.
Alternatively, an eligible beneficiary could opt to follow the ten-year rule, where their RMDs would be calculated based on an age plus one-year schedule and avoid early withdrawal penalties by setting RMDs on this schedule. While this can help them avoid early withdrawal penalties of 10% on early withdrawals, this strategy could increase total tax bills if their account is large; an alternative solution might be rolling the inherited IRA into their existing preexisting IRA instead.
Rollover method
If you are the spouse of someone who has passed away, “assuming ownership” allows you to circumvent the required minimum distribution rule that usually applies when inheriting an IRA.
Take regular minimum distributions (RMDs), but space them out over your expected lifespan in order to save on taxes.
Roll the account into an IRA or qualified employer plan such as a 403(b). This will enable you to avoid paying income tax and penalties; however, you must be wary not to make mistakes; for instance, withdrawing earnings from an inherited IRA that’s been open less than five years will incur additional taxes as these withdrawals don’t qualify for the five-year holding period rule – Roth IRAs included! It is best to consult a financial professional prior to making any changes.
Assuming ownership
Roth IRAs that are passed down through inheritance are tax-free for beneficiaries; however, withdrawals of earnings from them are subject to additional taxes. There are ways for beneficiaries of inherited Roth IRAs to limit this tax – using the assumption of ownership method can help their heirs reduce tax payments in this regard.
The initial distribution must take place by December 31st following an account owner’s death, or sooner if their younger spouse would have reached age 72 whichever comes first. For eligible designated beneficiaries who survive their original account owner’s passing, their distributions can be staggered over their lifetime; otherwise initial distribution must occur no later than 72 years old (whichever of those dates occurs first).
Spousal beneficiaries may also take advantage of the assumption of ownership method to treat their late spouse’s IRA as their own and take into account their life expectancy when calculating required minimum distributions – helping avoid the 50% failure to distribute penalty. It is essential, however, to consider income needs prior to taking on ownership of an IRA.
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