How Long Do You Have to Distribute an Inherited Roth IRA?
Due to recent retirement law changes, heirs now have less flexibility with inherited Roth IRAs. Where previously eligible beneficiaries could “stretch out” withdrawals over their lifetimes, now they must liquidate it within 10 years from when their loved one passed.
Beneficiaries include minor children, spouses and non-spouses. The IRS offers life expectancy tables to assist beneficiaries in deciding their distribution options.
Five-year rule
The five-year rule is an obligation that stipulates you must wait at least five years after inheriting a Roth IRA before withdrawing earnings. Its aim is to underscore that Roth IRAs should only ever be used for long-term investments, discouraging people from misusing IRA assets.
Note that tax years do not follow calendar years or 12-month periods as their timeframe.
The five-year rule applies to inherited Roth IRAs that are converted from traditional IRAs or other tax-deferred accounts, although it does not apply to rollovers between different custodians, nor if you change beneficiaries – such as changing to an inherited Roth. To avoid falling foul of this rule and incurring unnecessary taxes or penalties, it’s advisable to consult a qualified tax professional.
10-year rule
The 10-year rule is a new rule designed to help non-spouse beneficiaries of inherited IRAs avoid tax on withdrawals made within 10 years after the original owner dies. Financial planners initially anticipated that it would allow beneficiaries to take distributions according to their life expectancies; for example, taking more out during years with higher income levels while less during years with lower earnings. Unfortunately, guidance released in February 2022 put paid to that strategy.
Minors, spouses and chronically ill or disabled nonspouse beneficiaries could qualify to use the stretch IRA rule, which allows RMDs based on life expectancy of beneficiaries. Before making distribution decisions however, heirs should consult their advisor as these could increase tax brackets by thousands and potentially cost them dearly in taxes owed. Also they could consider converting traditional IRAs to Roths which don’t require minimum withdrawals.
Designated beneficiary rule
Eligible designated beneficiaries (EDBs) inheriting an IRA from an account owner who died prior to their RBD can choose either to take distributions throughout their lives, or move it into their own IRA and use their life expectancy calculation method for annual RMDs. Otherwise, the funds must be dispersed within 10 years – either way.
Non-spouse beneficiaries do not fare so well when inheriting an IRA from someone who died after 2019 and did not begin taking required minimum distributions (RBDs). Under the 10-year rule, non-spouse beneficiaries must empty out their inheritance within 10 years and include it on their income tax returns as withdrawal. To reduce taxes further, non-spouse beneficiaries can transfer or convert it to Roth status before withdrawing funds; it’s wise to seek advice from an advisor when making these decisions and also ensure beneficiary designations remain up-to-date!
Rollover rule
IRS has stringent rules surrounding IRA distributions, and that applies equally to inherited IRAs. A beneficiary can only make one rollover each year and must include all previously tax-exempt money distributed from an IRA as gross income. Their website provides extensive rules related to IRAs as a resource for answering frequently asked questions.
Hire an experienced financial professional to guide the process and maximize your inheritance while minimizing taxes and fees. He or she can provide guidance as to whether Roth conversion makes sense; for example if your tax rate exceeds that of the original account owner or if converting will trigger increased Medicare premiums or taxes on Social Security benefits – in such instances it might be wiser to stretch out distributions over time instead. In addition, financial professionals can help plan for unexpected events like death of loved one or career changes by helping plan ahead for unexpected scenarios such as potential outcomes like death of loved one or changes to career change by helping plan ahead with future planning assistance from them as well as helping plan for events like death of loved one or career change scenarios by planning ahead for events such as unexpected career changes by helping plan ahead with potential scenarios such as death of loved one and career changes by helping plan ahead and creating contingency plans.
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