Question: I inherited my spouse's Roth IRA account. He opened the account four years ago. I am now 72. What are my options? I read that I can either be treated as the owner of the account or the beneficiary. If I'm the owner and start taking distributions, will I have pay taxes on the distribution because of the five-year rule? If I'm the beneficiary, what then? No taxes due?
Answer: Jeremy Rodriguez, an IRA analyst with Ed Slott and Company, offered this response:
RMDs from Roth IRAs can be complicated because they involve not only the special spousal rules granted to spouse beneficiaries under the tax code, but the five-year qualified distribution rule and the ordering rules for Roth IRA distributions.
That said, a spouse beneficiary has the same options in a Roth IRA that he or she would have with a traditional IRA. That means the beneficiary can elect to either remain a beneficiary or execute a rollover (what I call, taking ownership of the account). However, as you'll see in the example below, the rollover is almost always going to make the most sense and that's really due to the Roth IRA ordering rules, which allow contributions to come out income-tax and penalty free. Thus, there aren't many situations where it would make sense for a spouse beneficiary of a Roth IRA to not execute the spousal rollover.
That said, if the spouse remains a beneficiary, then he or she will be subject to post-death RMDs which can be delayed until the deceased spouse would have reached age 70 1/2. As I mentioned above, distributions from a Roth IRA (including RMDs) are subject to the regular ordering rules. That means the first amounts withdrawn are considered contributions, which are always income tax and penalty free, regardless of how long the account was opened. The earnings are what are in play. If the account hasn't been opened for at least five years, then any earnings which are distributed will be subject to income taxes.
However, they will not trigger the early distribution penalty since the death exception would apply. Also bear in mind that the beneficiary gets to keep the original owner's holding period. That means if the Roth IRA had been open for three years when our Roth IRA owner dies, the beneficiary would only have to wait two more years to satisfy the five-year rule for qualified distributions.
On the other hand, the spouse beneficiary can roll over the inherited Roth IRA account to his or her own Roth IRA. In such an event, no future RMDs would be due. However, the spouse should take the current year's RMD (if one is due) before executing the rollover. The five-year rule would apply for future distributions, but the spouse gets to use whichever holding period is longer; their period or the period of the original spouse.
Example: Jessica is 57 and in 2019 inherits a Roth IRA from her husband, Darius. At the time of his death, Darius was 71 and the Roth IRA account had only been open for three years. Jessica has her own Roth IRA, which she opened 10 years ago. If Jessica decides to roll over the inherited money into her own Roth IRA, the inherited amount would be treated as a contribution and she gets to use her longer period (i.e., 10 years) for the purpose of measuring the five-year rule. That means in this situation, the five-year rule has been met.
However, remember that for a Roth IRA distribution to be qualified (meaning the entire thing is tax and penalty-free), the account must be opened for at least five years and the distribution must be after age 59 1/2, or due to death, disability, or the first-time purchase of a home.
In our example above, the rollover causes the account Jessica inherited from Darius to meet the five-year rule. However, she is under age 59 1/2, so earnings that are distributed from the account are taxable and subject to the 10% early distribution penalty. The death exception no longer applies because she has taken ownership of these funds (this is the same way the rule works with a traditional IRA). Essentially, she would have to wait until she reaches 59 1/2, to take a qualified distribution, which in our example is not very long.
On the other hand, let's say Jessica decides to remain a beneficiary of the Roth IRA. That means RMDs will need to be distributed from Darius's account. For the first two years, any earnings that are distributed along with the RMDs will be subject to income taxes. The 10% penalty would not apply since the amounts are distributed due to death. However, since the Darius had held the account for three years and Jessica gets to tack on that period, she only has to wait two more years before the five-year period would be satisfied. Once that period is satisfied, future distributions (including RMDs) are both income-tax- and penalty-free. The downside, however, is the RMDs must continue until she does the spousal rollover.
Finally, using our example, I'll give you my opinion; I think Jessica should execute the rollover. As I mentioned above, I can't envision many situations where this doesn't make sense. Executing the rollover stops future RMDs thereby keeping those funds in the market which, hopefully, are generating a decent return. If she wants access to a portion of that money after the rollover, the Roth IRA ordering rules allow her to withdraw contributions income tax and penalty-free. Even if you slightly tweak the facts, the rollover still makes sense. Let's say Jessica didn't have a Roth IRA, and decided to open one solely for the purposes of the spousal rollover. She would get to keep the three-year holding period that Darius had. That means she only needs to wait two more years before she satisfies the five-year rule for qualified distributions.
Given all this, I believe most custodians will automatically make the election for a spouse to take ownership of the account following the death of the Roth IRA owner. Essentially, the ordering rules make the analysis different than if we were dealing with a traditional IRA.
Got questions about taxes, Social Security, Medicare, retirement, investments, or money in general? Want to be considered for a Money Makeover? Email Robert.Powell@TheStreet.com.
Question: I inherited my spouse's Roth IRA account. He opened the account four years ago. I am now 72. What are my options? I read that I can either be treated as the owner of the account or the beneficiary. If I'm the owner and start taking distributions, will I have pay taxes on the distribution because of the five-year rule? If I'm the beneficiary, what then? No taxes due? Subscribe for full article
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