How Do I Cash Out an Inherited Roth IRA?
As soon as someone close to you dies, inheriting their IRA can be both an honor and a responsibility. There are rules you need to abide by such as non-spouse beneficiaries being required to close out their account within 10 years or it will become subject to probate proceedings.
Beneficiaries have several options when inheriting an account, including retitling it in their name or rolling it into an IRA they already possess – each option will come with different tax consequences.
1. Transfer to a new account
Before making any major decisions regarding an inherited Roth IRA, it’s advisable to consult a tax adviser. That way you can ensure all applicable rules and regulations are being observed.
As per IRS rules governing inherited IRAs, beneficiaries are expected to close an account within 10 years after the death of its original owner, unless they qualify as eligible designated beneficiaries (EDBs), such as an surviving spouse, disabled or chronically ill individual.
One solution is transferring the funds into your own IRA, which allows you to adhere to IRS rules while mitigating tax liability upon withdrawals. This may be done directly between accounts or using an indirect IRA-to-IRA rollover method wherein distributions from an inherited account are taken and deposited directly into your own. Either way, IRS Form 8606 must be filled out before moving forward with this process.
2. Take a lump-sum distribution
As soon as you receive an inherited Roth IRA, it’s advisable to seek advice from a financial professional experienced with these accounts. Their assistance will allow you to maximize your options while following all legal regulations while taking full advantage of decades of tax-advantaged compound growth.
If you opt for a lump-sum distribution, all the income tax will be due in one chunk. While this could be beneficial in clearing out an account quickly, it could also rob your future growth opportunities if not taken properly.
Under a new rule that took effect in 2019, non-spouse beneficiaries must emptidiate inherited Roth IRAs within 10 years after the death of the original owner. Before this change was implemented, their withdrawals could “stretch out,” potentially keeping assets growing for decades more. This option still exists for spouse beneficiaries as well as those disabled or chronically ill individuals as well as minor children and certain trusts.
3. Stretch out distributions over five years
As the designated beneficiary of an inherited Roth IRA, you can choose whether to spread its withdrawals out over your life expectancy – an attractive strategy if you prefer taking small withdrawals each year as it will minimize taxes over time. Alternately, irregular withdrawals could increase taxable income.
If you want to reduce distributions, begin by reviewing when and which kind of account was opened, such as traditional or Roth IRA, then assess whether withdrawing any money makes sense, according to Choate. While the IRS website provides comprehensive rules for inheriting retirement accounts, she advises speaking with a financial planner for advice about which options may work best in your situation and understanding complex tax rules and their effect on specific needs; ultimately the goal should be keeping as much money in an IRA for as long as possible.
4. Take a distribution based on your life expectancy
An experienced financial planner can assist in making the decision that best fits you. Natalie Choate of Create Wealth Financial Planning in Saint Johns recommends beneficiaries ask themselves whether taking out money now is desirable, or waiting. She suggests reviewing your own situation such as other investments or retirement savings available to you and consider its tax-advantaged growth over decades.
Kelly suggests using the single life expectancy method, which allows annual withdrawals based on one’s own life expectancy rather than that of the deceased person, for annual withdrawals based on individual life expectancies rather than those associated with the original account holder’s death. According to Kelly, this works best if beneficiaries older than the original account owner inherit the funds.
A new law, the Secure Act of 2019, mandates Roth IRA heirs to liquidate them within 10 years after an original owner dies unless certain criteria are met, such as being spouses or children younger than age 72. Furthermore, this new regulation prohibits “stretching” distributions as was allowed before.
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