How Do I Cash Out an Inherited Roth IRA?
An IRA inheritance can be an incredible source of riches. But it is crucial that you understand its tax ramifications before withdrawing funds from it.
Taken all at once, taking a lump sum could significantly increase your taxable income and jeopardise decades of tax-deferred growth. To prevent this scenario from unfolding, follow IRS regulations carefully when taking out cash in a lump sum form.
Taxes
An inherited IRA is typically either traditional or Roth account left by someone who died, making it hard to determine exactly how much Uncle Sam owes you and imposing several complex rules: non-spouse heirs must empty it within 10 years and withdrawals taxed according to current rates; they can reduce their tax bill by converting to Roth and extending withdrawals over their life expectancy.
Rule variations depend on whether the original account holder had already begun taking required minimum distributions (RMDs). If they hadn’t, their heir can treat it as his own until RMDs become necessary at age 72 (or age 73 if born in 2023 or later). Otherwise, beneficiaries must calculate their own RMDs using IRS tables based on life expectancy estimates; in certain instances preferential treatment may apply; such as spouses, minor children, chronically ill individuals and disabled people.
Withdrawals
Roth IRAs offer many benefits when you inherit them, including tax-free withdrawals when withdrawing funds. But their rules can be complex and any time you have questions on these accounts it would be wise to consult a financial planner or tax professional familiar with inherited accounts for advice.
As a general rule, your inherited account should remain separate from other retirement accounts that you own. Ideally, its title should read: “(Name of Deceased Owner) FBO (Your Name).” and cannot be combined into any existing retirement accounts in your own name.
Beneficiaries who inherit an IRA may use the life expectancy calculation and take distributions over their lifetime, though this option may only apply if they are the spouse or children of the deceased; otherwise they must meet one of three conditions to qualify – age under 21, disability, chronic illness etc. For non-spouse beneficiaries, however, the 10-year rule must be applied; once withdrawals begin you must deplete your account within 10 years or face taxes at ordinary income rates plus an additional 10% penalty tax rate.
Rollovers
Roth IRAs differ from traditional retirement accounts in that they do not require owners to take required minimum distributions at specific ages; however, any withdrawal of contributions prior to five years could incur taxes and fees related to investment earnings.
Heirs of Roth IRAs can move funds between retirement accounts in two ways – direct or indirect rollover. A direct rollover occurs when the plan sends you a check payable to your new IRA account with 60 days to deposit it before becoming taxable; while indirect rollover involves moving pre-tax accounts at the same financial institution or another entity.
Heirs must meet certain criteria in order to make eligible withdrawals from an inherited Roth IRA, including meeting an age requirement of greater or equal to 59 1/2, making a purchase or rebuild of their first home, paying qualifying unreimbursed medical expenses, or satisfying an IRS levie.
Conversions
Converting funds from traditional IRAs into Roth IRAs offers special tax benefits, allowing withdraws of contributions without penalty and earnings on investments free from federal income taxation.
Conversions may make sense if you anticipate being in a lower tax bracket in retirement than now, or if providing tax-free assets to your heirs is of top importance. It should not be done if immediate needs require using funds in an IRA account instead.
Converting involves contacting financial institutions and submitting paperwork. If you change your mind later on, recharacterizing the account back to traditional IRA status may allow for its conversion back. Be wary though: switching from an IRA into a traditional IRA could increase taxable income and trigger higher Medicare and Social Security premiums depending on your tax bracket; furthermore it could reduce how much of your estate qualifies for federal estate tax exemption.
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