When you inherit a roth ira, your relationship to the original owner and the age of the account determine which options you have.
The rules regarding inheriting Roth IRAs and other retirement accounts have changed since the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019 and the Coronavirus Aid, Relief, and Economic Security (CARES) Act in 2020.
Previously, an inherited Roth IRA could stay alone for life. But according to the rules of the SECURE Law, only certain beneficiaries can access the benefit for life, and they are the following: spouses, minor children of the deceased, disabled or chronically ill, and those who are not more than 10 years younger than the deceased, as brothers or sisters.
Anyone else inheriting a Roth IRA must distribute all the assets in the account within 10 years of the original owner’s death.
Why choose a beneficiary?
Any Roth IRA assets that you have not withdrawn will be automatically transferred to the beneficiaries you select. Often the beneficiary is a surviving spouse or her children, but it could be another family member or friend.
When you open a Roth IRA, you fill out a form to name your beneficiary, the person(s) who will inherit your account after your death. This form is more important than many people realize. If you leave it blank, the account may not go to the person you intended and you may lose some tax benefits.
You can inherit a Roth individual retirement account (IRA), and thus avoid a long judicial process for the heirs known as probate, as long as your beneficiary survives you and appears as such in the account, you can greatly simplify the procedures for getting ROTH IRA benefits.
If you have a Roth IRA and do not designate a beneficiary, then your total estate may be pooled and divided according to your state’s laws. Ultimately, your spouse or his or her children can keep your money, but they won’t have access to the same tax benefits as if you had named them as beneficiaries in the first place.
Inheriting a Roth IRA as a Spouse
Your options for inheriting a Roth IRA are different when the original account owner was your spouse. Here are your alternatives:
Spousal Transfer: This option is only available if you’re the sole beneficiary, you treat the Roth IRA as your own. This means that you’ll be subject to the same distribution rules as if it had been yours to begin with. To complete a spousal transfer, you’ll transfer the assets into your own new or existing Roth IRA.
- You can withdraw contributions at any time.
Earnings are taxable at your ordinary income tax rate and a 10% penalty if you withdraw any earnings before you reach age 59 ½ and it’s been at least five years since your spouse first contributed to the account.
- You can designate your own beneficiary.
Open an Inherited IRA, Life Expectancy Method: With this option, the assets are transferred into an special account called inherited Roth IRA in your name. You cannot add funds to the account and are still required to take RMDs.
- You have the option of deferring MRDs until the later of the date the original account holder would have turned 72, or the December 31 of the year following the year of his death.
Distributions are spread out over your life expectancy. However, if there are other beneficiaries, distributions are based on the life expectancy of the oldest beneficiary, unless separate accounts are established before December 31 of the year following the year of the original owner’s death.
- You can withdraw contributions at any time.
- Earnings are taxable unless the five-year rule is met.
- You will not be subject to the 10% early withdrawal penalty.
- The assets in the account can continue to grow tax-free.
- You can designate your own beneficiary.
Open an Inherited IRA, 5-Year Method: Under the Five-Year Method, the assets are transferred to an inherited Roth IRA in your name. You can spread out the distributions, but you must withdraw all of the assets from the account by Dec. 31 of the fifth year following the year of the original account holder’s death.
- You can withdraw contributions at any time.
- Earnings are taxable unless the five-year rule is met.
- You won’t be subject to the 10% early withdrawal penalty.
- Assets in the account can continue to grow tax free for up to five years.
- You can designate your own beneficiary.
Lump-Sum Distribution: If you choose this option, unlike with a traditional IRA, you won’t be taxed if you choose to receive the IRA’s funds in cash, all of the assets in the Roth IRA are distributed to you if the Roth IRA has been open for at least five years..
- There’s no tax on contributions in the account.
- The earnings are taxable if the account was less than five years old when the original account owner died.
Inheriting a Roth IRA as a Non-Spouse
Non-spouses include children, grandchildren, other family members, and friends. Your options are relatively limited because you aren’t allowed to treat the account as if it were originally your own; You have three alternatives if you inherit a Roth IRA as a non-spouse:
Open an Inherited IRA, Life Expectancy Method: With the Life Expectancy option, the assets are transferred into an inherited Roth IRA in your name. You’ll be subject to RMDs that must begin by Dec. 31 of the year following the year of the original account holder’s death.
With the passage of the SECURE Act, all distributions must be distributed within 10 years of the original owner’s death.When there are multiple beneficiaries, distributions are based on the oldest beneficiary’s life expectancy, unless separate accounts are established before Dec. 31 of the year following the year of the original account holder’s death.
- You can withdraw contributions at any time.
- Earnings are taxable unless the five-year rule is met.
- You won’t be subject to the 10% early withdrawal penalty.
- Assets in the account can continue to grow tax free.
- You can designate your own beneficiary.
Open an Inherited IRA, 5-Year Method: The assets are transferred to an inherited Roth IRA in your name with this option. You can spread out your distributions over time, but you have to withdraw everything by Dec. 31 of the fifth year following the year of the original owner’s death.
- You can withdraw contributions at any time.
- Earnings are taxable unless the five-year rule is met.
- You won’t be subject to the 10% early withdrawal penalty.
- Assets in the account can continue to grow tax free for up to five years.
- You can designate your own beneficiary.
Lump-Sum Distribution: With a lump-sum distribution, the assets in the Roth IRA are distributed to you all at once. Contributions are tax free, but earnings are taxable if the account was less than five years old when the original account owner died.
If you are the beneficiary of a Roth IRA, you have several options and it is important to consider them very carefully, since the tax consequences can vary. Before making important decisions about your inherited Roth IRA, consider consulting with a tax advisor to ensure compliance. with all the rules and maximize the growth of the money your loved one has left you.
