With an inherited Roth IRA, you have some great tax benefits; however, there are also some specific rules that apply to you as far as distributions are concerned and how the IRS treats those inherited accounts. Your best options will depend greatly upon whether you received the account from your spouse, when the person who originally owned the account passed away, and what type of beneficiary you are.
If you’re looking at your own retirement accounts, knowing the differences between an IRA vs 401(k) can make it easier to differentiate your personal retirement plan from how to manage your inherited retirement assets.
How Does an Inherited Roth IRA Work?
Roth IRAs do not have required minimum distributions while the first person to establish the account is still alive. When the person who established the account passes away, then the beneficiary distribution rules will begin to take effect. For RMDs (Required Minimum Distributions), the IRS will treat the person who established the Roth IRA as though they had passed away before the required beginning date.
The above-mentioned distinction may be especially relevant to most non-spouse beneficiaries.
The 10-Year Rule for Most Non-Spouse Beneficiaries
If you die after 2019, most adult children (and any other non-spouse designated beneficiary) must fully withdraw funds from their inherited Roth IRA on or before December 31st of the tenth calendar year after your death.
In general, if a beneficiary only has to meet the requirements of the 10-year rule, then they are not required to take an annual distribution from their Roth IRA during each of the first nine years. The beneficiary may decide how often to make withdrawals as long as the entire amount is removed from the account before the end of the 10 years.
The ability to withdraw funds tax-free for a longer period of time may provide you with the opportunity to grow your money tax-free for an even greater length of time than if you waited until year ten. However, waiting until year ten to begin making withdrawals from your account does not necessarily mean that is what will be most beneficial for you. Your investment risks, your cash requirements, your estate planning goals, and the state of the market are all factors that should play a role in determining how much you want to take out each year.
Are Inherited Roth IRA Withdrawals Taxable?
In most instances, a distribution that is “qualified” will be exempt from taxes.
The primary problem lies with the five-year holding period for a Roth IRA. If the original owner of the Roth IRA met the five-year requirement, then all of the money withdrawn by the beneficiary will be tax-free at the federal level. On the other hand, if the original owner’s Roth IRA was less than five years old when he/she passed away, then any value growth will still be subject to taxation until the five-year requirement is met. However, the contribution amount will continue to be tax-free.
Even though a beneficiary may be younger than 59½ years old, if they receive funds after the account owner has passed away, those fund distributions will typically not be subject to the standard 10% penalty for early distributions.
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Spouses Have More Options
The surviving spouse typically has more options for handling the account than any other beneficiary. The surviving spouse can either continue to hold the account as an inherited Roth IRA or convert the Roth IRA into his/her/their own account based upon the specific situation.
Original Roth IRA owners do not have required minimum distributions (RMDs) during their lifetimes; therefore, treating the inherited Roth IRA as their own may be particularly beneficial.
The selection may be based upon the age of the remaining spouse, their immediate cash flow requirements, and their overall plan for managing their estate.
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The Bottom Line
Inherited Roth IRA’s can be very tax-efficient as an inheritance; however, although the growth is tax-free, there are still deadlines for taking distributions from the account. The majority of non-spouse beneficiaries should know about the 10-year rule, and spouses and other designated beneficiaries may have other alternatives available.
Coordinate decision-making with your IRA Custodian as well as any other professional that can assist you in making these types of decisions, such as a financial planner, accountant, lawyer, etc., before transferring or distributing any asset from the estate.
Read more: how to calculate inherited IRA RMD
FAQs
Do I have to pay taxes on an inherited Roth IRA?
Qualified inherited Roth IRA distributions are generally federal-income-tax-free once the original owner’s five-year holding requirement has been satisfied. Earnings withdrawn before that requirement is met may receive different tax treatment.
Does an inherited Roth IRA have to be emptied within 10 years?
Most non-spouse designated beneficiaries inheriting after 2019 must empty the account by the end of the tenth year following the owner’s death. Certain eligible designated beneficiaries qualify for different rules.
Do I have to take annual RMDs from an inherited Roth IRA?
For many non-spouse beneficiaries subject to the Roth IRA 10-year rule, annual distributions during years one through nine generally are not required. The full balance must still be distributed by the applicable year-ten deadline.
Can I roll an inherited Roth IRA into my own Roth IRA?
A surviving spouse may generally have the option to treat inherited Roth assets as their own. Non-spouse beneficiaries generally must preserve the assets as an inherited IRA rather than rolling them into their personal Roth IRA.