Inheriting a Roth IRA

Key Takeaways

• Proper use of the 10-year rule with an inherited Roth IRA
• The distinction between EDBs and designated beneficiaries (DBs)
• Taxation on inherited Roth IRA distributions

Inherited Roth IRA

When exploring inheritance scenarios for Roth IRAs, a fundamental principle known as the “10-year rule” is critical. Before delving into the intricacies of various beneficiary options, a comprehensive understanding of this rule, as outlined by the Internal Revenue Service (IRS), lays the groundwork for informed decision-making.

The 10-year rule generally requires certain beneficiaries to fully distribute an inherited IRA by December 31 of the 10th calendar year following the year of the original account owner’s death. However, the rules vary depending on the beneficiary’s status, so it is important to determine whether the beneficiary is an eligible designated beneficiary, a designated beneficiary, or a non-designated beneficiary.

This article meticulously elucidates the implications of being an eligible designated beneficiary (EDB), a designated beneficiary (DB), or a non-designated beneficiary, offering a comprehensive insight into the options and tax implications within each category. We also discuss the tax treatment of inherited IRA distributions, unraveling the nuances of taxable and non-taxable distributions and contributing to a well-rounded understanding of the overall landscape.

For more information on options when you inherit a traditional IRA from your spouse.

The 10-year Rule

Before we get into the various inheritance scenarios of Roth IRAs, it’s important to understand the 10-year rule.

Under the SECURE Act, many beneficiaries who inherit a Roth IRA must fully distribute the account by December 31 of the 10th calendar year following the year of the original account owner’s death. For example, if the account owner dies in 2026, the inherited Roth IRA generally must be fully distributed by December 31, 2036.

Because Roth IRA owners are not required to take minimum distributions during their lifetimes, beneficiaries subject to the 10-year rule generally are not required to take annual distributions during years one through nine, provided the entire account is distributed by the end of the 10th year.

Eligible Designated Beneficiary Status

Inherited IRA Rules

First, you must determine if you are an eligible designated beneficiary (EDB) under IRS rules. You’ll qualify as an EDB if you are:

• The spouse of the deceased IRA owner
• A non-spouse beneficiary who is disabled or chronically ill, as defined by applicable IRS rules. (as defined by the Internal Revenue Code, Sections 72(m)(7) and 7702B(c)(2), respectively)
• A non-spouse beneficiary who is not more than ten years younger than the deceased IRA owner
• A minor child of the deceased IRA owner

Certain qualifying trusts may receive favorable beneficiary treatment under inherited IRA rules. If a trust meets the IRS requirements to be treated as a “see-through trust,” certain beneficiaries of the trust—not the trust itself—may be treated as designated beneficiaries for required minimum distribution purposes. Whether those beneficiaries qualify as eligible designated beneficiaries depends on factors such as their relationship to the deceased account owner, age, disability or chronic illness status, and the specific terms of the trust.

If you qualify as an EDB, here are your options when the Roth IRA account owner passes away:

• You’re the spouse; you have several options: treat the IRA as your own, elect to receive single-life expectancy distributions, or follow the 10-year rule for inherited IRAs.
• If you are a non-spouse beneficiary who meets the IRS requirements for permanent disability or chronic illness, or if you are not more than ten years younger than the deceased IRA account owner, you may choose to receive single-life expectancy distributions or follow the 10-year rule.
• A minor child of the deceased IRA account owner may generally take distributions based on their life expectancy until age 21. Once the child reaches age 21, the remaining inherited IRA becomes subject to the 10-year rule.

Age of Majority

For purposes of the inherited IRA rules, a minor child of the deceased account owner is treated as an eligible designated beneficiary until age 21. Once the child reaches age 21, the remaining inherited IRA generally becomes subject to the 10-year rule and must be fully distributed by the end of the 10th calendar year following the year the child reaches age 21.

Designated Beneficiaries

The distinction arises between eligible designated beneficiaries (EDBs) and designated beneficiaries (DBs), each encapsulating a unique set of options and limitations. A designated beneficiary (DB) assumes this role when they are named as beneficiaries of the IRA but do not meet the qualifying criteria for eligible designated beneficiary status.

An example of a designated beneficiary could be an adult child of the IRA owner who does not otherwise qualify as an eligible designated beneficiary.

Unlike eligible designated beneficiaries, designated beneficiaries are generally subject to the 10-year rule. This requires the entire inherited Roth IRA to be distributed by December 31 of the 10th calendar year following the year of the original account owner’s death.

Inherited IRA Split Between Siblings

When multiple siblings are named as beneficiaries of an inherited IRA, the account can generally be divided into separate inherited IRAs or into separate shares for each beneficiary. Each sibling’s inherited account remains titled as an inherited IRA for the benefit of that individual beneficiary; the siblings do not jointly own a single IRA.

Separate inherited accounts may be established after the original account owner’s death. However, for the separate-account rules to apply independently for required minimum distribution purposes, the separate accounts generally must be established by December 31 of the calendar year following the year of the original IRA owner’s death.

Once separate accounts are established, each sibling’s share can generally be administered in accordance with the distribution rules that apply to that beneficiary.

Lump-sum Distribution

Beneficiaries generally have the option to take a lump-sum distribution of an inherited Roth IRA at any time. A lump-sum distribution completely withdraws the beneficiary’s share of the inherited account and satisfies the requirement to distribute the account within the applicable beneficiary distribution period.

For an inherited Roth IRA, the tax treatment depends on whether the distribution is qualified. Contributions are distributed tax-free, and most distributions of earnings are also tax-free if the Roth IRA has satisfied the applicable five-year holding period. If the Roth IRA has not yet met the five-year requirement, some distributed earnings may be subject to ordinary income tax. The 10% additional tax for early IRA distributions generally does not apply to distributions made to a beneficiary after the account owner’s death.

Non-Designated Beneficiary

If the beneficiary of a Roth IRA is not an individual—for example, an estate, charity, or certain trusts—the beneficiary is generally considered a non-designated beneficiary for required minimum distribution purposes.

Because Roth IRA owners are treated as having died before their required beginning date, a non-designated beneficiary is generally subject to the five-year rule. This means the entire inherited Roth IRA must be distributed by December 31 of the fifth calendar year following the year of the account owner’s death. No annual distributions are required during years one through four, provided the account is fully distributed by the end of year five.

Certain qualifying trusts may be treated differently if they meet the IRS requirements to be treated as a see-through trust, in which case the underlying trust beneficiaries may be considered when determining the applicable distribution rules.

Taxation on Inherited Roth IRA Distributions

The Roth IRA is an incredible retirement- and estate-planning vehicle we’ve discussed extensively on this blog.

If you inherit a Roth, you may wonder how taking distributions from it will affect your taxes. Here’s what you need to know.

• Distributions of the original amount contributed to the Roth are never taxable.

• Earnings distributions are generally tax-free once the five-year holding requirement has been satisfied. The five-year period begins on January 1 of the first tax year for which the original account owner made a contribution to any Roth IRA.

Taxation on Inherited Roth IRA Distributions Example

Suppose a Roth IRA owner dies in 2026. If the owner made their first contribution to any Roth IRA for tax year 2021 or earlier, the five-year holding requirement has generally been satisfied. In that case, distributions to the beneficiary, including earnings, are generally tax-free.

If the owner first contributed to a Roth IRA for tax year 2022 or later, the five-year holding period may not yet be complete. Contributions can still generally be distributed tax-free, but earnings distributed before the five-year requirement is satisfied may be taxable.

For purposes of the five-year rule, the period begins on January 1 of the tax year in which the owner made their first Roth IRA contribution, even if the contribution itself was made after the applicable tax-filing deadline.

Inherited Account

Inheriting an IRA requires a comprehensive understanding of the intricate web of rules and considerations that govern the future of these assets. The “10-year rule” underpinning this tenet establishes a fundamental framework that influences the entire spectrum of beneficiary choices. Delving into the various scenarios, from eligible designated beneficiaries (EDBs) to designated beneficiaries (DBs) and beyond, exposes the interplay of options and limitations, each path offering distinct avenues for wealth preservation and distribution.

Inheritance, as witnessed in the realm of Roth IRAs, is far from a uniform path. The choices, responsibilities, and opportunities unveiled allow beneficiaries to navigate the journey with a keen understanding of the rules and implications. Talk to a financial advisor today if you are unsure or want an expert opinion and advice for your financial future and inheritance.