How Do I Cash Out an Inherited Roth IRA?
There are various Roth IRA options for inheritors, depending on your relationship to the deceased and other considerations. Your tax situation and future plans could impact which option would best fit.
An inherited IRA is an individual retirement account (IRA) set up on your behalf by someone other than yourself – usually your spouse, child, unrelated individual, trust or estate. Distribution rules differ for non-spouse beneficiaries.
Options
There are various options to consider when inheriting a Roth IRA, each of which will have tax repercussions. You could take an immediate lump-sum distribution and access all funds immediately; this option will increase taxable income and forego any potential tax-deferred growth on the account.
Alternately, you can assume ownership (also referred to as moving funds into your own account). This will allow you to maintain control of the account while still taking distributions based on your life expectancy – although certain requirements must be fulfilled in order to do so.
Your other options for leaving an inherited IRA to someone is via trusts or non-qualified trusts you control, however this will limit withdrawal options and subject it to regular income taxes if not sole trustee. Before making any decisions concerning an inherited IRA it’s wise to consult a financial professional first.
Taxes
One important consideration when inheriting Roth IRAs is taxes. Heirs do not need to take Required Minimum Distributions (RMDs), like their original account holder did, until year 10. Should an heir withdraw funds before then, any withdrawals would be taxed at their personal income tax rates instead of at Roth IRA’s tax-free rates.
Beneficiaries have the option to spread out their withdrawals over their life expectancies, which may prove particularly effective for nonspouse beneficiaries who wish to reduce tax rates over time and avoid penalties and fees.
Careful consideration must be made when investing for retirement, particularly with your current income and estimated retirement date in mind. Seek advice from an experienced fee-only certified financial planner regarding your situation and options available to you; using this type of planning could prevent costly errors from becoming costly mistakes that cost thousands in the end.
Withdrawals
Your options for handling an inherited Roth IRA depend on your relationship to and the details of their estate or trust, which can make dealing with one more challenging. Beneficiaries who are spouses and younger than the deceased can utilize an exemption rule that allows withdrawals over life expectancy to lower tax bills significantly.
Keep in mind, however, that distributions from an IRA count as income and must be reported on your taxes – this includes earnings withdrawn from an inherited Roth IRA as they will be taxed at your ordinary income tax rate until they meet the five-year holding period requirement which allows tax-free withdrawal of contributions.
Inherited Roth IRAs require you to take minimum distributions (RMDs) starting at age 71 unless you’re younger. Otherwise, the IRS imposes a 10% penalty on any earnings withdrawn before age 59 1/2.
Conversions
If your spouse of the deceased account owner died, their IRA assets can be assumed as yours through “spousal rollover.” You can then treat them as your own and change the RMD schedule to be reflective of your life expectancy rather than that of theirs.
Convert their IRA to your Roth IRA; but beware that any nondeductible contributions your spouse made become taxable when you make this change.
As inheriting an IRA can be complex, seeking advice from experienced professionals is crucial to reaping its full potential and taking full advantage of tax-deferred growth over decades. To begin this process, fill out our questionnaire and we’ll connect you with qualified financial advisors at no charge;
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