Estate Planning

What You Need to Know About Inheriting a Roth IRA

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by Alli Thomas

Sep 14, 2021

We recently talked about what options you have when you inherit a traditional IRA from your spouse. But what about a Roth IRA? And what if you inherit the Roth IRA from someone who wasn’t your spouse?

 

The 10-year Rule

Before we get into the various inheritance scenarios of Roth IRAs, let’s review the 10-year rule.

According to the IRS, IRA beneficiaries who do not opt to take life expectancy distributions from the inherited IRA must withdraw the entire balance of the inherited IRA by December 31 of the year containing the tenth anniversary of the IRA account owner’s death.

 

Eligible Designated Beneficiary Status

First, you’ll need to figure out 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 permanently disabled or chronically ill (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 10 years younger than the deceased IRA owner
  • A minor child of the deceased IRA owner

Some trusts may also be considered an EDB, but not all of them.

 

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

  1. If 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.
  2. If you are a non-spouse beneficiary who meets the IRS requirements for permanent disability or chronic illness, or you are not more than 10 years younger than the deceased IRA account owner, you may choose to receive single-life expectancy distributions or follow the 10-year rule.
  3. If you are a minor child of the deceased IRA account owner, you may elect to receive single life expectancy distributions. But, as soon as you turn 18, the account will be subject to the 10-year rule.

 

Designated Beneficiaries

You are a designated beneficiary (DB) if you are a named beneficiary of the IRA, but do not qualify as an EDB. An adult child of the account owner is one example of a DB.

As a DB, you only have one option with inherited Roth IRAs: follow the 10-year rule. The IRS no longer allows DBs to choose single life expectancy distributions.

 

Non-Designated Beneficiary

Although it may sound strange at first, this category covers IRA beneficiaries that don’t have life expectancies. Examples of beneficiaries that fall under this umbrella are estates, charities, and certain types of trusts that do NOT qualify as EDBs.

A non-designated beneficiary of a Roth IRA must distribute the assets within five years of the account owner’s death.

 

Taxation on Inherited Roth IRA Distributions

The Roth IRA is an incredible retirement- and estate-planning vehicle that we’ve talked about a lot on the blog.

If you inherit a Roth, you may be wondering 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 not taxable, ever.
  • Distribution of earnings on contributions to the Roth are not taxable as long as they happen at least five years after the first contribution to the Roth was deposited by the deceased account holder. For example, if the Roth IRA owner dies this year and made their first contribution to the account in tax year 2016 (or earlier), the beneficiary will not be taxed on any distribution from the account – contributions OR earnings.

Let’s look at an example. If a Roth IRA owner dies in 2020 and they opened their first Roth IRA for tax year 2015 or earlier, the entire account is available for distribution to their beneficiary, tax-free. This is the case even if the original Roth IRA account was closed and transferred to another Roth IRA in the interim, and even if contributions for tax year 2015 were put into the account through April 15, 2016.

If the deceased account owner opened their first Roth IRA in the 2016 tax year or later, distribution of earnings would be taxable if it occurs before the five-year period is complete.

 

Questions?

I know this was a lot to absorb! If you have questions about setting up a Roth or what to do with a Roth that you’ve inherited, our advisors can help. Click here to set up a free, no-obligation appointment to talk with one of them.

 

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Alli Thomas

Alli Thomas has worked in the financial services industry for nearly 20 years, with a focus on retirement-related investing. She began her career as a FINRA-licensed participant-services call-center associate at Vanguard, and then moved to Principal Financial Group, where she worked closely with employers, assisting with retirement plan set-up and design, selecting appropriate plan investment offerings, and maximizing employee participation through targeted education campaigns and enrollment meetings. Alli has also worked as a qualified 401(k) administrator and registered investment advisor for several small investment firms. She now writes about all things investment- and finance-related, leveraging her extensive experience and passion for retirement planning to help investors make well-informed financial decisions.

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