Q. What are the rules for an inherited Roth IRA?
A. It all depends on who the beneficiary is.
That’s because there are different rules for distributions when the beneficiary is a spouse or a child or a charity.
It’s important to understand the rules to avoid the imposition of a severe penalty for failing to make a required distribution, said Gary Botwinick, an estate planning attorney and chair of the taxation/trusts and estates department at Einhorn Harris in Denville.
Botwinick said one of the appealing features of a Roth IRA is that while the original owner is living, there are no Required Minimum Distributions.
This means that the Roth IRA can continue to grow tax-free for a very long time, he said.
When the beneficiary dies though, the rules change.
“If a spouse is the beneficiary of an inherited Roth IRA, the spouse can roll over the Roth IRA into the spouse’s name and continue to allow the funds to grow tax-free with no required distributions during the inheriting spouse’s lifetime,” Botwinick said.
If the spouse fails to rollover the Roth IRA, and instead treats it as an inherited Roth IRA, then required distributions must begin when the spouse reaches age 70 1/2, he said.
But if a child or grandchild is the beneficiary, then he or she will be required to withdraw the funds over his or her lifetime.
“This means that the younger the beneficiary, the more time he or she has to withdraw the money,” he said. “Keep in mind that, unlike with traditional IRAs, a distribution from a Roth IRA will not be an event that will trigger an income tax.”
If the beneficiary is a charity or the owner’s estate, or if the owner fails to name a beneficiary, then the entire Roth IRA is subject to the five-year rule, and the entire Roth IRA must be distributed over the five years following the death of the owner, Botwinick said.
There’s one more complication to consider.
“If, at the death of the Roth IRA owner, the funds have not been held in the Roth IRA for at least five years, then the earnings on such funds will be taxable to the beneficiary,” Botwinick said. “There will not, however, be a penalty for an early withdrawal.”
Hope that helps!
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