If you inherit a Roth IRA, there are various options available to you; it’s essential that you seek advice from an expert with regard to inherited IRAs.
First, determine if you are the designated beneficiary. If so, withdrawal must take place within 10 years. Other beneficiaries such as children, disabled people or chronically ill people may qualify for exceptions to this 10-year rule.
Spousal Rollover
If a spouse is the sole beneficiary of their deceased partner’s Roth IRA, they can treat it as their own and avoid taking Required Minimum Distributions (RMDs). To do this, RMDs must be taken within 10 years following his or her death unless an estate planning strategy was used (prior to 2020 this option existed but was eliminated with SECURE Act).
Unless the spouse meets this deadline, RMDs from their new inherited account must be taken using an IRS Single Life Table – this requires them to withdraw all balance within 10 tax years, potentially incurring an enormous income tax bill. Although inheriting an IRA can be daunting, understanding its operation and what your options are can help maximize its worth.
Lifetime Distributions
Although inheriting a Roth can be an incredible windfall, it’s essential that you know all of your options when handling it. IRA inheritance rules differ significantly from traditional retirement accounts and expert guidance should always be sought when handling it. For instance, the IRS mandates required minimum distributions within 10 years after an inherited Roth owner dies; however, exception categories such as spouse, disabled beneficiary and beneficiaries under 10 years younger may allow beneficiaries to reduce this timeframe significantly and receive RMDs based on your life expectancy instead of that of their deceased counterpart.
Surviving spouses may also opt for a stretch Roth IRA, which defers required minimum distributions until the individual would have been 72, according to Choate. This allows an inherited Roth to continue growing tax-free over multiple generations.
Lump Sum Distributions
IRS rules surrounding Roth IRA inheritance can be complex and their improper handling could have serious repercussions for beneficiaries. Beneficiaries should seek professional advice in order to understand all available options as well as any tax implications of making decisions regarding these accounts.
If you are either the spouse, eligible designated beneficiary, or younger than 10 years younger than the original account owner, lump sum withdrawals can be used without incurring penalties or taxes on them. Please be aware that withdrawals generally count as income and must be taxed accordingly.
Option 2 is to roll over the IRA into an existing one in your name, treating it as your own IRA and thus avoiding the 10% penalty if you are under 59 1/2. This way, investments will continue growing tax-deferred until required minimum distributions must begin being taken from it.
If you choose not to opt for either the spousal rollover or lump sum withdrawal option, required minimum distributions (RMDs) may be necessary. You can calculate an annual RMD using the IRS Single Life Expectancy Table that corresponds with your age in the year following the original account owner’s death.
Investment Options
Financial advisors can assist beneficiaries in understanding the rules related to Roth IRAs. Furthermore, they can develop strategies designed to maximize investment potential.
Contrary to traditional IRAs, which require their owners to start taking distributions at age 72, inherited Roth accounts aren’t required to start dispersing funds until after their original owner would have reached age 72 – giving the account time to grow tax-free for decades more.
The 10-year rule applies equally to non-spousal heirs; however, due to the SECURE Act of 2019, this option has largely been disallowed for non-spousal heirs who inherit an IRA after December 31st 2019.
One of the most popular strategies for heirs to use their inherited Roth IRA to invest in income-producing assets is dividend stock funds, which invest in companies that pay regular dividends to shareholders and then reinvested the earnings back into themselves, potentially becoming hugely valuable investments due to their consistent payments.
