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:
- 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.
- 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.
- 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 59� 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 70�,
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. |