A new retirement law has altered some of the rules surrounding Roth accounts inherited by their heirs, forcing them to liquidate them within 10 years or face an enormous income tax bill.
However, there are ways around this. Designated beneficiaries – spouses, minor children, stepchildren or legally adopted children of the deceased account owner – who qualify as beneficiaries can roll their inheritance into preexisting IRAs owned by themselves.
You’ll need to meet certain requirements.
Due to recent tax code updates, when inheriting a Roth IRA from someone you love who died within 10 years, it is necessary to abide by IRS rules outlined by them. You have until Dec 31 of that same year which marked 10 years postmortem before all assets must be liquidated from within it and all withdrawals from an inherited Roth are typically nontaxable provided the account had been held for five or more years prior to receiving it as inheritance.
Eligible beneficiaries for accounts held by individuals include their spouse, children and grandchildren as well as disabled or chronically ill individuals, trusts or disabled veterans. Any beneficiary who does not fall into this category must either follow the 10-year rule or take a lump sum distribution.
Non-eligible designated beneficiaries consist of any individuals that do not fall within any of the other categories listed, including friends and relatives who do not fall into eligible designated beneficiary category. They must adhere to the 10-year rule or pay an early withdrawal penalty of 10% of any earnings before age 59 1/2.
You’ll need to disclaim the account.
Lily can disclaim her IRA and transfer it to someone else, such as her mother or one of her children, but this move has complex tax ramifications. Before the SECURE Act heirs could “stretch out” their withdrawals over their lifespan to reduce taxes; now most nonspouse beneficiaries must empty the account within 10 years, which may prove challenging given tax rules apply when it comes to transfers between family members. Finally, this may also trigger generation skipping transfer (GST) taxes that apply when moving assets among family members between family members – another consideration that needs careful thought when disclaiming an IRA!
Lily must meet certain conditions in order to qualify for disclaiming her account, such as not using it to pay bills or make investments changes. She should consult a financial advisor or attorney prior to disclaiming as this can ensure a smooth process that aligns with their final wishes for the IRA owner.
You’ll need to roll it over.
Roth IRA rules can be complex and vary based on their original owner, beneficiary, and when they passed away. Usually, their heirs must either empty it within 10 years after death or withdraw all assets over that time period (with one exception: spouse-owned accounts can allow beneficiaries to extend distributions over multiple lifetimes).
However, you have ways around these rules. Your options will depend on factors like your relationship to the deceased, when they were due to retire and expected retirement date as well as tax considerations and immediate cash needs and creditor protection. It may be worth consulting a financial planner who specializes in IRA inheritances to determine your best approach; depending on your situation you could possibly rollover their IRA into another one or combine it with existing retirement accounts.
You’ll need to take a lump sum distribution.
If you withdraw money from a Roth IRA prior to age 59 1/2 or without meeting the five-year rule, any earnings and possible 10% penalties are taxed; however, you can avoid this tax burden by rolling it over into another qualified account such as your own IRA or another qualified account.
Non-spouse beneficiaries must use the life expectancy method to calculate RMDs; however, withdrawals may be staggered over a 10-year period. A recent law change — SECURE Act — does away with this 10-year rule for many non-spouse beneficiaries, except minor children; chronically ill or disabled people or those within 10 years of original account owner’s death.
These inheritance rules may seem complex, yet it’s essential that you understand all of your options. If you need guidance when making decisions related to an inheritance account, get help from an expert with knowledge in that area – perhaps a financial advisor familiar with inherited retirement accounts can guide your choices in making the best choice.