Roth IRA inheritance rules can be complex. No matter whether the original account owner was married to their beneficiary or not, SECURE Act changes have added further complications to these matters.
Beneficiaries of inherited IRAs have two options for taking required minimum distributions (RMD). One method allows funds to continue growing tax-free for decades while another requires them to empty out their account within 10 years.
Reporting a Roth IRA Distribution
Inherited IRAs can be complex. For the best outcomes and peace of mind, it’s wise to consult a fiduciary financial professional or estate professional. This way you will ensure that all available options and the resulting consequences for both yourself and your family are understood fully.
An individual who inherits a Roth IRA may withdraw both contributions and earnings tax-free, even if they’re under 59.5 years of age. However, required minimum distributions (RMDs) must begin being taken out starting one year after the original owner has passed.
If the original account holder was a spouse, their beneficiary can treat the account as their own and use the life expectancy method to calculate RMDs (see Choate above). Non-spouse beneficiaries must empty an inherited Roth IRA by December 31 of the 10th year following its owner’s death; using the 10-year rule could extend this deadline and possibly save on taxes; however it could mean missing out on potential growth opportunities and growth benefits.
How to Report an Inherited Roth IRA Distribution
Depending on who inherited your Roth IRA from, treating it like your own is possible without incurring penalties; however if someone else gave it to you instead of your spouse. In such a case, follow different rules when withdrawing funds.
Beneficiaries typically must empty a Roth within 10 years after its original owner passes away and take required minimum distributions (RMDs) starting on Dec 31 of each year following, if they’re aged more than 59 1/2.
Due to these restrictions, it may be wise to avoid cashing out an inherited Roth in one lump sum. Instead, take withdrawals gradually over time in order to keep taxes as low as possible – this should be discussed with a fiduciary financial professional and estate planning expert before making your final decision. For guidance in regards to IRA distributions please refer to IRS rules which offer comprehensive guidance for this topic.
Reporting an Inherited Roth IRA Distribution on Your Tax Return
As inheritances of Roth IRAs can be complex and require difficult decisions, beneficiaries need to know how long the original account owner held their Roth IRA to determine whether withdrawals of earnings will be tax free. Natalie B. Choate’s book Life and Death Benefits for Retirement Planning (8th Ed 2019) provides excellent resources regarding IRA withdrawals and the five-year rule.
Dependent upon their circumstances and age, beneficiaries may benefit from waiting five years before taking distributions to maximize growth of an inherited Roth investment.
Non-spouse beneficiaries, on the other hand, must deplete any Roth IRA they inherit within 10 years regardless of age under new regulations established by the SECURE Act in 2020. There may be options available to stretch RMDs over lifetimes to avoid this rule but those interested should consult a trusted financial planner for advice before taking this path.
Reporting an Inherited Roth IRA Distribution on Your Estate Tax Return
As soon as a loved one passes, estate planning should become a top priority. Beneficiaries should review IRA beneficiary designations carefully to avoid inheriting an inherited IRA that may convert into an inheritance account.
An inherited IRA is an account established after someone dies that provides funds for his or her beneficiaries – usually spouse or child. An inherited IRA can either use pre-tax money, depending on how its original IRA was set up; or may take advantage of after-tax investments as per its own original setup.
No matter the structure of an original account, beneficiaries who inherit an IRA must start taking required minimum distributions (RMDs) according to an RMD schedule based on either their life expectancy or the 10-year rule – including Roth IRAs. With certain exceptions such as widow(er), minor children or chronically or permanently disabled people this rule does not apply.