How Do I Report an Inherited Roth IRA Distribution?
Americans hold over $12 trillion invested in individual retirement accounts (IRAs). But if you inherit one, navigating your options may prove complex.
One option for taking ownership is designating yourself as the owner and treating assets like they’ve always belonged to you – this can allow your IRA to grow for decades before having to take required minimum distributions (RMDs). Other strategies could be:
Reporting an Inherited Roth IRA Distribution
An inherited Roth IRA may present complex challenges even by IRS standards. If you need assistance, speaking to an experienced retirement specialist could help lower taxes.
What you do with an inherited IRA depends on whether its previous owner was your spouse or non-spouse. If he or she passed away while you were married, you have two options for handling their account: roll it into an account in your own name or take distributions based on either life expectancies (yours or theirs).
If you are not the spouse, your options for inheriting Roth IRAs are more limited. While you can open one and take RMDs over either your lifetime or that of the deceased owner’s, liquidating it before Dec. 31 of the 10th year posthumously following their death is required by law. It’s essential that you understand these rules before making decisions regarding any inherited Roth IRAs you inherit from any source.
The Five-Year Rule
Before the SECURE Act was enacted in 2022, beneficiaries who inherited an IRA could extend distributions by using an IRS uniform life expectancy table to make payments over five tax years; now beneficiaries must withdraw all investment earnings within this deadline or face a penalty fee.
Gagnon stated that funding of an IRA begins when its first contribution or Roth conversion occurs, either directly or via Roth conversion. A beneficiary who withdraws converted funds prior to meeting required minimum distribution period requirements would incur an early withdrawal penalty of 10% of those funds, Gagnon warned.
Non-designated beneficiaries such as spouses are subject to the five-year rule; however, beneficiaries such as estates or trusts may be exempt.
The 10-Year Rule
As its name implies, this rule stipulates that non-spouse beneficiaries must empty any Roth IRAs they inherit within 10 years. There may be exceptions to this rule as well.
Beneficiaries, spouses and minor children who qualify as designated beneficiaries, as well as individuals living with disability or chronic illness, are exempt from this rule; however, those electing the 10-year rule should take care not to withdraw an amount that puts them into a higher tax bracket.
Notably, spouse beneficiaries have more withdrawal options than non-spousal beneficiaries, including rolling an inherited Roth into their own account and stretching out distributions. Therefore, an heir hoping to reduce taxes will need to consider both his/her individual circumstances as well as those in his or her family – for example a high-income heir may benefit more from leaving it with either his/her spouse or minor children so it continues to accrue tax-free over an extended period.
The Life Expectancy Rule
If you are the surviving spouse who treats an account as his or her own, withdrawals don’t need to occur annually; but other beneficiaries must make withdrawals within their life expectancies or face a 10-year rule which requires them to withdraw the full balance within 10 years.
If the original owner reached his or her Required Minimum Distribution age, their surviving spouse can start taking RMDs in the year following his or her death. These must then continue every year over his or her remaining life expectancy.
Rules regarding inherited Roth IRAs can be complex, making tax advice from an experienced professional essential. Failure to follow them correctly could result in severe IRS penalties – for instance if your RMD isn’t taken by April 1 of the year following when its original owner would have reached his or her RBD threshold, you face a 50% fine from them!
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