What Happens When You Inherite a Roth IRA?
When inheriting a Roth IRA, there are certain considerations you must keep in mind to avoid incurring penalties from the IRS. Understanding all your options is essential in reducing penalties from doing something incorrectly.
As an example, a surviving spouse could roll their late partner’s account into their own IRA to avoid early distribution penalties, but this will not meet their required minimum distribution (RMD) obligation.
Inherited IRA rules can be complex, and the IRS website can be helpful in getting you started; however, for best results it’s wise to consult a financial advisor for advice pertaining specifically to your circumstances.
Non-spouse beneficiaries who inherit Roth IRAs from someone who died must empty them within 10 years, with some exceptions such as minors, people with disabilities and chronically ill beneficiaries. Failing to take required distributions could incur penalties.
RMDs are determined by dividing an inherited account’s balance at the end of last year by an IRS single life table factor corresponding to their age. If an RMD isn’t distributed within its required deadline, a 50% penalty on what wasn’t taken will apply; multiple year delays incur double penalties. Alternatively, assets could be moved into your own IRA for tax-deferred growth.
Required minimum distributions
The IRS mandates that most owners of individual Retirement Accounts (IRA) withdraw a set amount each year as “Required Minimum Distributions (RMDs).” This rule also applies to beneficiaries, with Roth IRA beneficiaries having to take RMDs based on age and life expectancy, according to an IRS uniform life expectancy table calculation.
There are exceptions to this rule; such as minor children of the original account owner; people still in school or chronically ill/disabled individuals; and spouses of original account holders.
These rules can be complex, so it’s often best to consult a financial advisor. SmartAsset’s free tool connects users with pre-vetted advisors in their area who can assist in understanding these regulations and selecting an ideal strategy for them. Working alongside an expert ensures you comply with regulations while avoiding penalties.
Lump sum distributions
As the beneficiary of an inherited Roth IRA, if your deceased spouse made Roth contributions or conversions during that year that are tax-exempt and recovery them tax free can be advantageous from both a creditor protection standpoint and creditor avoidance standpoint. You should however, distribute this type of Roth IRA annually before December 31 of the year following his or her death.
Non-spouse beneficiaries can extend distributions over their life expectancies using IRS life expectancy tables. This option can be especially useful for younger beneficiaries looking to maximize the growth of their inheritance.
Beneficiaries must carefully consider their own financial situations when withdrawing funds from an inherited Roth IRA, according to Natalie Choate of Life and Death Planning for Retirement Benefits. Withdrawing too much at once may force you into higher tax brackets. You have two withdrawal options – taking an annual withdrawal amount, or taking out lump sum which avoids the early withdrawal penalty but will still be fully taxable upon distribution.
Rule for inheriting an IRA may be complex, so there are resources available to you to help understand its requirements and make wise decisions. Start your research on the IRS website before consulting with a financial professional for more specific advice.
As well as the 10-year rule, there are exceptions for designated beneficiaries such as surviving spouses, chronically or permanently disabled people and children under 10 years younger than the original account owner. Such beneficiaries can “stretch out” their withdrawals by calculating an RMD that takes into account their expected life expectancy.
As with any inheritance, inheriting a Roth IRA requires careful planning in order to avoid paying taxes on it and tax penalties; however, there can be many benefits including being able to withdraw a lump sum without incurring penalties of 10%. It’s essential that you select an option which best meets your circumstances.
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