An inherited Roth IRA comes with its own set of rules and regulations, making it essential to fully comprehend any tax implications before making decisions about how best to use it.
First option would be to transfer the money over into a new IRA account for spouses; non-spouse beneficiaries will not have this option available to them.
Taking a distribution
If you inherit an IRA from someone who has passed away, there are various withdrawal strategies you can employ when withdrawing funds from it. Take periodic distributions (RMDs) directly from the account or roll it over into another. Both options carry their own tax consequences so it is wise to consult a fiduciary financial professional regarding any decisions you make and to understand their impact before making your final choice.
One option for disbursing an IRA’s assets over five years may be beneficial if you do not need the money immediately; however, failure to meet this timeframe could incur a 50% penalty fee.
Another option would be to roll over an inherited IRA into an existing IRA, which will enable you to fulfill any RMDs due in the year of death and avoid paying the 10% early withdrawal penalty. Unfortunately, doing this makes the IRA taxable; however, long-term benefits could be lost in doing this.
Rolling it over into your own account
If you inherit a Roth IRA, there will be complex rules dictating its treatment. For instance, if the original owner was your spouse, keeping it open and taking tax-free withdrawals until your death could be an option; otherwise, due to new retirement law passed in 2019, all accounts must be closed within 10 years and empty out by then.
Non-spouse beneficiaries who inherit an IRA must transfer it into an “inherited IRA,” take RMDs according to their age, and empty their accounts within 10 years or face an early withdrawal penalty of 10%. However, spouses meeting certain requirements can roll the money over into an existing or new IRA of their own to continue growing tax-deferred and withdraw without penalty provided they comply with required distribution rules.
Taking a spousal transfer
Once an IRA has been inherited, its management options may be chosen from among several options available to them. As rules for inherited IRAs can be complex and vary depending on whether the beneficiary is spouse, non-spouse, family member or an entity (like trust or estate), consulting a tax advisor can be invaluable in understanding all available choices and managing an inheritance IRA properly.
Spouse beneficiaries may choose a spousal transfer or assumer an IRA as a way of moving assets over to their accounts, known as an “asset transfer or assumption.” This resets the schedule for required minimum distributions based on life expectancies; making this option attractive for those who have reached retirement age.
Take a lump-sum distribution if needed immediately and are willing to consider any increased tax burden when making their decision. However, this route does require paying income taxes and possibly incurring the 10% early withdrawal penalty on top of any initial funds that may have already been released from an inherited Roth IRA.
Taking a lifetime distribution
One option for accessing an IRA is taking a lump sum distribution and paying your normal income tax rate on it, whether traditional or Roth. Please keep in mind that non-spouse beneficiaries may still be subject to RMDs and early withdrawal penalties of 10% early withdrawal penalty.
Assuming ownership of an inherited IRA (commonly referred to as spousal transfer or taking over an account) allows you to treat it like your own and will also reset its schedule of required minimum distributions.
Assuming your inheritance includes pre-tax contributions from its benefactor, an inherited IRA may be subject to income taxes when withdrawing funds over your lifetime. As professional advice may help avoid costly mistakes and maximize returns for any substantial accounts, seeking professional guidance before making this choice is recommended; especially if the account is substantial. You can find advisors online who specialize specifically in these accounts or hire a financial planner with this experience for best results.