Inherited Roth IRAs

What happens when you inherit a Roth IRA

Roth accounts that have been passed down can present complex retirement rules. Assets acquired via inheritance tend to follow the same distribution order rules that applied to original owners’ accounts; old contributions must first be distributed out before earnings can be taken from account.

Prior to 2020, heirs could reduce their tax bill by delaying withdrawals over their expected lifespan. But changes to the law have altered this strategy.

Survivors

Slott notes that if the original owner of a Roth IRA dies before reaching 70 1/2, their beneficiaries can take their first required minimum distribution (RMD) by December 31 of the year following his/her demise – this deadline being relatively quick; therefore it would be prudent to consult an experienced tax professional prior to withdrawing money from their account.

Nonspouse beneficiaries – such as children or other relatives – can take advantage of nonspousal accounts by adhering to strict rules for this purpose, according to Slott. For instance, they should transfer any inherited money directly into their own names before treating it as their own by retitling it, then using IRS life expectancy tables recalculate annual withdrawal amounts accordingly and not mix inherited and non-inherited funds together as doing so will force beneficiaries to follow different rules with faster withdrawal periods, according to him.

Designated Beneficiaries

If you are the surviving spouse of the original account owner, an inherited Roth IRA could provide the perfect solution for you. By opening one in your name and rolling over its contents into it, tax-free withdrawals could occur at any time but distributions would depend on life expectancy under IRS rules – for more advice specific to your circumstances please speak with a financial and tax professional advisor.

Children, friends and relatives of the deceased must receive distributions based on their life expectancies in accordance with IRS regulations and have 10 years to deplete their IRA before penalties kick in.

Individual beneficiaries who are less than 10 years younger than the original account owner have the option of electing to use the five-year rule instead. You must elect this option by December 31 of the year following their death; it does not apply if an IRA was established through their deceased employer; only individual beneficiaries may use this rule.

Eligible Beneficiaries

Roth IRAs can be complex. It is wise for heirs to seek advice from an independent fiduciary financial and/or estate professional when inheriting one, in order to ensure it is managed appropriately, while avoiding unexpected taxes or penalties from occurring.

Under rules implemented by the Setting Every Community Up for Retirement Enhancement (SECURE) Act, non-spouse beneficiaries are expected to empty Roth IRAs within 10 years after an original account holder passes away; however, distributions may be spread out over their lives or those of the deceased account holder.

Exceptions to the 10-year rule may exist if the beneficiary is either: (1) a minor child who can defer withdrawals until age 26; or (2) chronically ill or disabled individuals less than 10 years younger than the original account holder (such as siblings or friends). In those instances, distributions are tax-free while earnings would normally be subject to income tax; if taking this route early withdrawal penalties of 10% would apply – otherwise earnings would become taxed as regular income and any withdrawals before age 59 1/2 would incur an early withdrawal penalty penalty of 10% early withdrawal penalty.

10-Year Beneficiaries

If you inherit a Roth IRA from someone other than your spouse, the 10-year rule can help simplify its administration. Under this option, you have until Dec 31 of the 10th year following their death to empty it or face penalties.

This strategy may work best when dealing with beneficiaries who fall within lower tax brackets, such as children. However, its calculations become less appealing if your beneficiary lies within higher-tax brackets – one large withdrawal could push them over into that tax bracket and thereby necessitating higher payments to Uncle Sam.

Heirs who do not opt for the 10-year rule must empty their Roth IRAs within five years after the death of the original owner, including estates and certain trusts that do not designate beneficiaries themselves. Slott recommends that these nondesignated beneficiaries combine both their inherited funds as well as any noninherited ones into one IRA in order to simplify annual RMD calculations more easily while not losing out on decades worth of tax-free growth potential.


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