As soon as you inherit a Roth IRA, the options open up. Depending on your relationship to the deceased and their manner of death, RMDs or full withdrawal of funds could be required within 10 years.
Other options allow inheritance assets to grow tax deferred over decades, but the rules can be complex and restrictive; moreover, the 2019 SECURE Act altered some regulations.
Taxes
The IRS has set forth complex regulations regarding Roth IRA inheritance distributions. A financial advisor can assist in complying with these laws while simultaneously managing withdrawals to minimize taxes due.
If the IRA has been transferred into your own name, then there may be some flexibility available to you. By rolling it over into an IRA owned by you instead, the stretch option allows for taking distributions based on life expectancy rather than taking immediate distributions each year.
By making regular withdrawals of small amounts each year, this strategy allows your money to continue growing over time while you receive tax savings in the form of step up in basis upon selling those investments later. It may be wiser, however, to simply take distributions as needed and withdraw accordingly.
Distributions
IRS rules specify how you must distribute an inherited Roth IRA, differing from RMD requirements for traditional IRAs and made more complex by the fact that once you inherit one you cannot contribute any more money yourself to it. Professional guidance may often be beneficial when managing such accounts if there is significant money involved.
An inherited Roth IRA requires annual Required Minimum Distributions (RMDs). These distributions are calculated based on its total balance at the time of original owner’s death multiplied by an appropriate fraction using your life expectancy as numerator and original owner’s age as denominator.
If you fail to take your RMDs as required, a penalty of 50 percent of what should have been distributed must be paid; also, ordinary income tax applies on any earnings withdrawn before reaching your required distribution age.
Spousal Transfers
When inheriting an IRA, your options for managing it depend on several factors including your relationship to the deceased and age, whether the account is Roth or traditional and when it was opened. Natalie Choate, founder of Create Wealth Financial Planning in Saint Johns, Florida notes this fact.
Spouses who inherit Roth IRAs may opt to transfer the assets into their own IRA and receive distributions based on their life expectancy rather than that of the original owner, in what’s known as a stretch IRA account. This gives their funds the potential to grow for decades more!
Non-spouse beneficiaries, on the other hand, must withdraw all their inherited IRA funds within 10 years to avoid an income tax bill of their own. It is therefore wise to consult a fiduciary financial professional prior to withdrawing your funds from an inherited IRA.
Non-Spouse Beneficiaries
Inherited Roth IRAs must follow the same distribution rules as other IRAs; these regulations can be complex for non-spouse beneficiaries who inherit an inheritance and should seek professional advice before acting on it.
Alternatively, as the spouse beneficiary of a deceased’s IRA account, you can roll its assets into your own IRA and treat it like your own (via spousal transfer). This allows you to tailor annual distributions based on your life expectancy rather than that of the original owner’s and reduce tax burden over time.
Non-spouse beneficiaries must withdraw funds from an inherited Roth IRA within 10 years after the death of its account holder, which is known as the required minimum distribution rule (RMD). You should follow both this and five-year rule requirements as failing to do so could incur taxes and penalties.
