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Taking the Mystery Out of Inherited Roth IRAs and the Stretch Strategy

 

Roth IRA holders generally name beneficiaries to inherit the assets in their IRAs.  Non-spouse beneficiaries are required to eventually take Required Minimum Distributions (RMDs) from an inherited Roth IRA, and the amount and payout period, after the IRA holder’s death, depends on who is designated as the IRA beneficiary(ies) and their age at the time of the IRA holder’s death.  Most beneficiaries choose to take the smallest payment that the law allows, and at the latest possible date, which allows the Roth IRA the potential to grow tax-free over their lifetime. 

 

Inheriting a Roth IRA

If a spouse is named as the primary beneficiary of a Roth IRA, they have the following options after the holder’s death:

·        Lump-sum distribution

·        Establish a beneficiary IRA account and eventually begin RMDs

·        Deplete the entire balance before the end of the fifth year following the year of the IRA holder’s death (generally called the five-year rule)

·        Roll the assets into their own Roth IRA (and name their own beneficiaries)

 

Non-spouse beneficiaries who inherit Roth IRAs do not have the rollover option.  However, the following options are available:

·        Lump-sum distribution

·        Deplete the entire balance before the end of the fifth year following the year of the IRA holder’s death (generally called the five-year rule)

·        RMDs based on their own life expectancy, determined by referencing the IRS Single Life Expectancy Table   

 

Stretching a Roth IRA 

To “stretch” is a strategy to distribute the IRA assets well beyond the lifetime of the person who established the IRA.  In order to do this, after the holder’s death:

 

  1. The designated beneficiary(ies) chooses to take RMDs based on their own single life expectancy and must begin by December 31 of the year following the IRA holder’s death.
  2. Upon inheriting the IRA, the beneficiary is allowed to name their own beneficiary(ies) through a designation of beneficiary form, if the IRA custodian permits.
  3. If the beneficiary of the inherited IRA dies before reaching their full life expectancy, the Roth IRA assets can continue to be paid to the next beneficiary over the remaining distribution period of the deceased beneficiary.

 

As an example, an individual who is age 75 names a grandchild who is 20 years old as a beneficiary.  While the IRA holder is alive, no RMDs are taken.  However, after the IRA holder’s death, the beneficiary, who chooses the life expectancy payment option, must begin RMDs in the year following the IRA holder’s death.  These payments will be based upon the grandchild’s own single life expectancy factor, which is 62.1 years (IRS Single Life Expectancy Table) for someone age 21.  And, if the tax laws don’t change, the 62.1 years is a guaranteed payout period to the beneficiary or to the beneficiary’s named beneficiary(ies). 

 

RMD taxation and penalties

Contributions (and Traditional IRA conversions) made to Roth IRA are all after-tax dollars, and withdrawals (other than earnings) are not subject to taxation.  In addition, if it’s been at least five tax years from the first contribution or conversion date, the earnings may generally be withdrawn tax free.  And, the 10% penalty associated with IRA distributions to those under 59½ years of age is not applicable for inherited IRA distributions.

Failure to take an RMD from an inherited Roth IRA will result in a 50% excise penalty tax on the undistributed amount. 

 

Distribution Reference Chart

The following chart may be used to determine inherited Roth IRA Required Minimum Distribution options.  Note that a beneficiary’s age as of December 31 of the year of distribution is used to determine the life expectancy (LE) factor for RMDs.

Beneficiary

Distribution options

Spouse

·         Total distribution

·         Five-year rule

·         LE payments based on own LE beginning in the year following the year the IRA owner would have turned 70½, recalculated each year

·         Rollover into their own Roth IRA

Non–Spouse

and Multiple Beneficiaries

 

·         Total distribution

·         Five-year rule

·         LE payments based on single LE of beneficiary.  LE factor is reduced by one for each subsequent year

 

Multiple Beneficiaries Only

·         LE payments based on the oldest beneficiary’s LE.  If the IRA is separated into individual beneficiary IRAs by 12/31 of the year following the year of the IRA owner's death, each beneficiary may use their own LE

 

Qualified Trust

·         Total distribution

·         Life expectancy payments based on the oldest beneficiary of the trust

·         For subsequent years, this factor is reduced by one

Non-qualified Trust

·         Total distribution

·         Five-year rule

·         LE payments not available

No Beneficiary Designation

·         Total distribution

·         Five-year rule

·         LE payments not available

Charity

·         Total distribution

·         Five-year Rule

·         LE payments not available

Estate

·         Total distribution

·         Five-year Rule

·         LE payments not available

This information is for educational purposes only.  It is always recommended that you seek the aid of a competent tax advisor or tax attorney to assist you with tax advice and guidance.

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