Which choices you have for managing the money in a Roth IRA as a beneficiary depend on the account’s age and your relationship to the original owner.
With the enactment of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019, there are now new regulations governing the inheritance of Roth IRAs and other retirement accounts, especially for non-spousal heirs.
When a spouse dies, their Roth IRA becomes part of their estate. The beneficiary of the Roth IRA will then have several options for how to handle the account. This guide will explore the different options available to beneficiaries of Roth IRAs, including spouses, and how each option affects taxes and distributions.
Understanding Roth IRA Beneficiaries
A Roth IRA beneficiary is the person or entity named to receive the assets of the Roth IRA after the original account owner’s death. The beneficiary can be anyone, including a spouse, child, other family member, friend, or charity.
Options for Spouses Inheriting a Roth IRA
Spouses who inherit a Roth IRA from their deceased spouse have several options available to them:
1. Become the Account Owner:
Spouses who are the sole beneficiaries of the Roth IRA can choose to become the account owner themselves. This option allows them to treat the inherited Roth IRA as their own, meaning they won’t be subject to required minimum distributions (RMDs) during their lifetime. However, their beneficiaries will be subject to RMDs when the spouse eventually passes away.
2. Rollover to an Inherited IRA:
Spouses can also choose to roll over the inherited Roth IRA assets into an inherited IRA, also known as a beneficiary IRA. This option allows them to stretch out the RMDs over their own life expectancy, potentially reducing their tax burden.
3. Cash Out the Account:
Spouses can also choose to cash out the Roth IRA and receive the funds as a lump-sum distribution. This option may be desirable if the spouse needs immediate access to the funds. However, it’s important to note that any earnings on the Roth IRA will be taxed as ordinary income if the account has not been open for at least five years.
Options for Non-Spouse Beneficiaries Inheriting a Roth IRA
Non-spouse beneficiaries, such as children, grandchildren, or other family members, have fewer options available to them. They cannot become the account owner or roll over the assets into an inherited IRA. Instead, they must either:
1. Withdraw the Funds Within 10 Years:
Under the SECURE Act, non-spouse beneficiaries must generally withdraw all funds from the inherited Roth IRA within 10 years of the original account owner’s death. This means taking annual distributions until the account is depleted.
2. Withdraw the Funds Within 5 Years (5-Year Rule):
In certain situations, non-spouse beneficiaries may be able to withdraw the funds within five years of the original account owner’s death. This option is available if the beneficiary is a minor child of the deceased, a disabled or chronically ill individual, or someone who is not more than ten years younger than the deceased.
Tax Implications of Inherited Roth IRAs
Distributions from inherited Roth IRAs are generally tax-free, as long as the account has been open for at least five years. However, there are a few exceptions to this rule:
- Early Withdrawals: If the beneficiary takes a distribution from the Roth IRA before the five-year rule is met, the earnings portion of the distribution will be taxed as ordinary income.
- RMDs: If the beneficiary chooses to stretch out the distributions over their life expectancy, the RMDs will be taxed as ordinary income.
Frequently Asked Questions
Q: What happens to a Roth IRA when a spouse dies without a beneficiary?
A: If a spouse dies without a beneficiary named on their Roth IRA, the assets will become part of their estate and will be distributed according to the terms of their will or state law.
Q: Can a non-spouse beneficiary inherit a Roth IRA and roll it over to their own Roth IRA?
A: No, non-spouse beneficiaries cannot roll over inherited Roth IRA assets into their own Roth IRA. They must either withdraw the funds within 10 years or 5 years (under certain conditions) or leave the funds in the inherited Roth IRA and take distributions according to the rules outlined above.
Q: What happens to a Roth IRA when both spouses die?
A: If both spouses die, the beneficiaries of the Roth IRA will be determined according to the terms of the deceased spouses’ wills or state law. The beneficiaries will then have the same options available to them as outlined above.
Inheriting a Roth IRA can be a complex process, and it’s important for beneficiaries to understand their options and the potential tax implications. By carefully considering the different options available, beneficiaries can make informed decisions that meet their individual needs and financial goals.
Option 1: Spousal Transfer
The Roth IRA is treated as your own when you make a spousal transfer. The same distribution guidelines that applied when it was first yours will apply to you. The assets will be transferred into your named account or your current Roth IRA in order to finalize a spousal transfer.
- You can withdraw contributions at any time.
- The five-year rule states that earnings are taxable until you reach the age of 59 and that it has been at least five years since your spouse made the first contribution to the account.
- This option is only available if you’re the sole beneficiary.
- You can designate your beneficiary.
Option 3: Open an Inherited IRA, 5-Year Rule
The assets are moved to an inherited Roth IRA in your name in accordance with the Five-Year Rule. Spreading out the distributions is allowed, but you have to take all the money out of the account by December 31 of the fifth year after the initial account holder’s passing
- 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.
- The account’s assets may increase tax-free for a maximum of five years.
- You can designate your beneficiary.