There is confusion about what happens when you inherit a Roth IRA. The rules surrounding required minimum distributions (RMD) from an inherited Roth IRA are different than the Roth IRA or Roth 401(k) you opened and funded yourself. Additionally, the RMD rules for your Roth IRA or Roth 401(k) differ from those for a traditional IRA or 401(k).
Roth IRA Inheritance Rules
The rules differ for owning and contributing to a Roth IRA versus a traditional IRA or 401(k) plan. You shouldn’t be surprised that there are also different rules when you inherit a Roth IRA. The good news is that a Roth IRA can typically be inherited tax-free. But unlike a Roth IRA in your name, you will not be allowed to keep money in an inherited Roth IRA forever. Non-spouse beneficiaries must take distributions each year based on their life expectancies. That requirement starts the year after the original owner’s passing.
Related; How To Maintain Financial Freedom In Retirement
Inherited Roth IRA From A Spouse
Spousal beneficiaries have the option to roll over the inherited Roth IRA into a Roth IRA account in their names. The main advantage of this tax-planning strategy is you will not be forced to take RMDs. Assuming you don’t need the money now, it can keep growing and be withdrawn at some later date tax-free.
Of course, if the account is tiny or you need the money today, you could also have the option to pull out all the money tax-free.
See IRS Publication 590, “Individual Retirement Arrangements,” for more information about the fine print and the life expectancy table for required withdrawals.
It is common to leave your retirement account to your spouse. Many states even require this beneficiary election.
When spouses inherit a Roth IRA, they have a valuable third option unavailable to non-spouse IRA beneficiaries. Widows and widowers can roll over the inherited Roth IRA into retirement accounts in their names. This allows them to skip setting up a separate inherited Roth IRA and eliminates the need to take RMDs from the inherited Roth IRA account.
New SECURE Act Rules For Inherited Roth IRAs
You may or may not have heard of the Setting Every Community Up for Retirement Enhance Act of 2019, more commonly known as the SECURE Act. Most famously, this pushed the IRA RMD beginning date from 70.5 to 72 years old.
It also dramatically changed the RMD rules for the inherited Roth IRA. The SECURE Act requires the entire balance of an inherited IRA to be withdrawn within 10 years of the original owner’s death. This applies to all IRA inheritances after January 1, 2020. Remember, this is based on the date of death, not when you received the IRA funds. This new 10-year rule applies regardless of the decedent’s age and whether or not the decedent was taking RMDs.
Important Exceptions To The Inherited Roth IRA 10-Year Rule
This is where working with a tax-planning expert can be extremely valuable. There are several exceptions to the 10-year rule for several types of beneficiaries. Exceptions include a surviving spouse, a disabled or chronically ill person, a child who has not yet reached the age of majority, and a beneficiary who is not more than 10 years younger than the decedent.
If you are a beneficiary and fit into one of these exception categories, you will not be forced to completely withdraw the inherited Roth IRA funds based on the 10-year rule. Beneficiaries in other exception categories (children, disabled, or beneficiaries not more than 10 years younger than the decedent) will still be allowed to take RMDs based on their life expectancies.
The Five-Year Inherited Roth IRA Distribution Rule
The inherited Roth IRA rules listed above only apply if you receive your inheritance as a listed beneficiary of the deceased person’s Roth IRA. If you receive Roth IRA funds via probate or will, your time to withdraw all funds is cut in half. You will have five years to withdraw all funds from the inherited Roth IRA. This is why keeping your retirement account beneficiary designations up to date is so important.
Your trusted financial planner can help guide you through this difficult time. If that person offers tax planning (most advisors don’t), they can also help you make the most of your inheritance by guiding you to options that minimize taxes. If nothing else, a trusted financial planner can help take some of the stress out of all the choices, you are forced to make when you least want to think about anything financial. Simply checking the wrong box on a form could cost you a large percentage of your inheritance—no fun.