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Taking the Mystery Out of Inherited Roth IRAs

When establishing a Roth IRA or Roth qualified plan account, it’s important to designate beneficiaries to inherit your assets when you pass away. In addition, when life events such as marriage, divorce, or birth of a child occur, this is typically a good time to review and update your beneficiaries accordingly. Upon your passing, your beneficiaries will be required to take distributions from their inherited Roth IRAs, but the payout period and applicable rules depend on who is designated as beneficiary. While the same rules generally apply for both Roth IRAs and Roth qualified plans, a plan document may dictate or limit payout options.

The enactment of the SECURE Act (effective January 1, 2020) brought several changes to inherited Roth IRA rules. The following charts will outline inherited Roth IRA distribution options if the account owner passed away in 2020 or after or prior to 2020:

Inherited Roth IRA Options Based on Beneficiary (for death occurring 2020 or after)

Beneficiary Type Following Death of Account Owner
Spouse
  • Total distribution
  • Five-year rule2
  • Required minimum distributions (RMDs) based on beneficiary’s life expectancy beginning in the year the Roth IRA owner would have turned age 72
  • Rollover to own Roth IRA
Non-Spouse1
  • Total distribution
  • Ten-year rule3
Qualified Trust4
  • Total distribution
  • Ten-year rule3
Estate, Charity, or Non-Qualified Trust
  • Total distribution
  • Five-year rule2


Inherited IRA Options Based on Beneficiary (for death occurring prior to 2020)

Beneficiary Type Following Death of Account Owner
Spouse
  • Total distribution
  • Five-year rule2
  • Required minimum distributions (RMDs) based on beneficiary’s life expectancy beginning in the year the Roth IRA owner would have turned age 70½
  • Rollover to own Roth IRA
Non-Spouse
  • Total distribution
  • Five-year rule2
  • RMDs based on beneficiary’s life expectancy starting in the year after death
Qualified Trust
  • Total distribution
  • Five-year rule2
  • RMDs based on the oldest beneficiary of the trust’s life expectancy starting in the year after death
Estate, Charity, or Non-Qualified Trust
  • Total distribution
  • Five-year rule2


1
Non-spouse beneficiary exceptions that may still take RMDs over their life expectancy include disabled and chronically ill individuals, a minor child of the deceased account owner, and a non-spouse beneficiary that is no more than 10 years younger than the deceased. Please note, once minor children reach the age of majority in their state, the ten-year rule will apply.


2 Five-year rule does not require a distribution in any year, but the inherited account must be fully distributed by December 31 of the fifth anniversary of death.

3 Ten-year rule does not require a distribution in any year, but the inherited account must be fully distributed by December 31 of the tenth anniversary of death.

4 Certain trusts, including charitable remainder trusts and “see-through” trusts benefiting an eligible beneficiary, may avoid the ten-year rule and allow for longer payout periods. If naming a trust as beneficiary, it is important to consult with a trust attorney.

SUCCESSOR BENEFICIARIES

Beneficiaries who inherit Roth IRAs and Roth qualified plans may designate successor beneficiaries to inherit the account when that primary beneficiary passes away. If the original account owner died in 2019 or prior with a non-spouse beneficiary that passes away in the future, the successor beneficiary will be subject to the ten-year rule upon the primary beneficiary’s passing. If the original account owner died in 2020 or after with a non-spouse beneficiary that passes away in the future, the successor beneficiary will continue the original beneficiary’s ten-year rule.(Note: The 10 years does not reset.)

IMPORTANCE OF STRETCHING AN IRA

The stretch strategy is utilized by having the beneficiary(ies) distribute only their RMD each year. This allows the Roth IRA to continue to compound earnings in a tax-free manner over the life expectancy of the primary beneficiary, thus stretching the Roth IRA over a maximum period of time and minimizing taxation each year. Generally, Roth IRA and Roth qualified plan owners that passed away in 2019 or prior may allow their beneficiaries to utilize the stretch strategy. For death occurring in 2020 or after, spouse beneficiaries and certain non-spouse exempt beneficiaries may take advantage of the stretch strategy. In addition, for Roth IRA and Roth qualified plan owners that passed away in 2020 or after, it is generally advised for beneficiaries to take no distributions in years 1-9 and take a full tax-free distribution in year 10, so the inherited Roth IRA has the optimal amount of time to compound tax-free earnings.

DISTRIBUTION TAXATION AND PENALTIES

Contributions (and conversions) made to a Roth IRA are after-tax dollars, and withdrawals (other than earnings) are not subject to taxation. In addition, if it has been at least five tax years from the first Roth IRA funding date, the earnings may generally be withdrawn tax-free. The 10% penalty for IRA distributions before age 59½ is waived for inherited Roth IRA distributions. Failure to take an RMD by the deadline (typically December 31 each year) from an inherited Roth IRA will result in a 50% penalty on top of ordinary income tax (if applicable on earnings) for the undistributed amount. RMDs from inherited Roth IRAs generally begin in the year after death.

This information is for educational purposes only. Stifel does not provide legal or tax advice. You should consult with your legal and tax advisors regarding your particular situation.

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