Distribution Rules for the Inherited Roth IRA

When an individual dies prior to withdrawing funds from a Roth IRA, the beneficiary will be subject to new distribution rules. Essentially, the beneficiary will receive similar benefits as the contributor would have received if they had not passed away. However, there are some unique rules, and these rules can depend on exactly who is inheriting the IRA.

Estate Tax

The estate tax applies to all inheritance, including any funds inherited in a Roth IRA. Roth IRA's are not exempt from taxes, but there is one reason why they may be preferable to traditional IRA's in terms of taxes owed upon inheritance. With a traditional IRA, the contributor has not paid taxes on the money that was placed in the account. This means the sum can be subject to taxes later, and this will happen upon inheritance. With a Roth IRA, post-tax dollars were contributed and are no longer subject to tax. Therefore, the total taxable sum on the estate can be lower even if the amount being left behind is slightly higher.

Income Tax

In terms of income tax, an inherited Roth IRA is treated much the same as if the original contributor was still alive. There are a few exceptions that can apply. When a contributor takes money out of the account before the qualified age of 59 1/2, the contributor pays a 10% penalty. This penalty does not apply to a person inheriting the sum; he or she can withdraw early without paying addition income taxes. A Roth IRA must be in existence for five years before withdrawals can be made, however, even if the beneficiary is the one making the withdrawal. Some distribution rules do concern whether or not the person inheriting the sum is a spouse or non-spouse, however, so this information must be taken into account.

Spouse vs. Non-Spouse Beneficiaries

A non-spouse beneficiary does not need to combine an inherited Roth IRA with his or her own IRA accounts. Instead, this individual can start withdrawing; in fact, he or she must start withdrawing from the inherited Roth IRA within five years of the contributor's death. The entire account can be distributed within five years or within the lifetime of the beneficiary.

A spouse recipient is subject to different regulations, however. If a beneficiary spouse elects to do so, he or she can treat the inherited IRA as his or her own IRA, joining it with other IRA accounts. This means the person will not be subject to mandatory disbursement. The individual will not be able to withdraw funds before the qualifying age of 59 1/2, however, if they choose to treat the IRA as if it is their own. The main benefit for a spouse choosing to treat an IRA in this manner comes if the spouse is rather young at the time of death. This can help provide benefits later in life, during retirement, when the IRA is intended to start paying out. If a spouse inherits an IRA late in life, it makes more sense to collect the distributions.

blog comments powered by Disqus