How Do I Cash Out an Inherited Roth IRA?
In 2019, the SECURE Act modified IRA rules, mandating that nondesignated beneficiaries must fully withdraw an inherited Roth account within 10 years after its original owner has passed. Prior to this legislation, beneficiaries could use life expectancy methods for dispersal.
Beneficiaries can select one of three distribution options for their inherited IRAs, each having different tax implications.
Taxes
Roth individual retirement account contributions are made after-tax, but earnings withdrawn before five years has elapsed are subject to regular income tax rates. Heirs of an IRA have several options when they inherit it.
If the original account holder did not take required minimum distributions prior to their death, their beneficiaries can choose between leaving their assets alone and letting them grow tax-free for as long as they desire; or rolling them over into an IRA in their name so as to continue enjoying tax benefits.
Recipients who take required minimum distributions must abide by a 10-year rule; exceptions include spouses, minors, disabled or chronically ill individuals and people less than 10 years younger than the original account owner. It can be challenging inheriting retirement accounts when rules change often; to best protect your future investments consult a tax or investment specialist about which options might work for your specific circumstances.
Withdrawals
No matter who the eligible designated beneficiary of an inherited IRA may be, any withdrawals you take out will be taxed depending on how it was transferred and with whom. For example, withdrawals from Roth accounts belonging to spouses of original account owners tend to be tax-free while earnings withdrawals subject to ordinary income tax rates if only opened for five years or less.
Before withdrawing any assets from an inherited IRA, it’s advisable to speak with a tax specialist in order to understand your options and avoid penalties. A stretch strategy might be beneficial; taking required minimum distributions (RMDs) over your life expectancy or that of the deceased account owner might help manage taxes effectively.
Adjusting the timing of your withdrawals can help minimize tax obligations. For instance, taking more out during years when your income drops than normal could help to cut taxes significantly.
Rolling into an IRA
IRAs are tax-advantaged retirement accounts that allow funds to grow tax-free if contributions are made prior to taxes and earnings are deferred until withdrawals are taxed as income. Individuals can invest in either a traditional, Roth, or SEP IRA for self-employed people; each type has annual contribution limits on traditional and Roth accounts respectively.
After an inherited IRA owner dies, beneficiaries can choose whether to treat it like their own and start taking RMDs immediately or distribute the account until either its contents have been depleted or Dec. 31 of the 10th year since original account holder died. Heirs who are minor children, chronically ill or disabled can stretch out withdrawals over their lifetimes.
Tax considerations of an inheritance IRA recipient’s personal situation is of prime importance when making decisions regarding how best to handle their inheritance, so investing in professional advisors may help maximize choices and prevent unexpected tax surprises later. Planning ahead now could prevent unexpectedly large tax surprises down the line.
Assuming ownership
Under prior rules, beneficiaries could postpone withdrawals and associated taxes until later in life, however with the implementation of SECURE Act of 2019 this has changed, potentially leaving beneficiaries exposed to an enormous tax bill if they’re not careful.
One option is to roll the assets over into your own IRA account, which would enable them to continue tax-deferred growth until retirement age – but also requires you to comply with minimum required distribution (RMD) rules and pay income tax as well as a 10% penalty on money withdrawn prior to age 59 1/2.
Assume ownership of an inherited Roth IRA by taking a lump-sum distribution; however, this would eliminate any tax-deferred growth potential. Another option would be donating it directly to charity which doesn’t care about minimum distributions and can take their funds whenever they wish; though most wouldn’t choose this path, it may be appropriate in certain instances.
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