Inherited Roth IRA

Submitted by William Harris on Thu, 2011-04-07 19:29

Simple background: In March, we had a client pass away at the age of 83. In 2010, we converted his IRA to a Roth IRA. He had named his two daughters as beneficiaries.

I assume inherited ROTH IRA is the same as inherited regular IRA?

I also assume the following:

Two new inherited ROTH IRA accounts are to be opened. Titled as John Doe, Deceased 3/2011, FBO Daughter #1 and a second account John Doe, Deceased 3/2011, FBO Daughter #2.

I assume RMD would be based on the oldest daughter’s DOB.

Can the Roth IRA be split prior to paying beneficiaires by a trustee so that each daughter could use their own DOB for RMD purposes.

Any other land mines or strategies in this area, please let me know.

Thanks in advance.



Submitted by Alan Spross on Thu, 2011-04-07 20:00

Each beneficiary should create separate accounts as soon as they determine that they will not ask the executor to recharacterize the conversion. The deadline for that decision is 10/17/2011. Note that since a spouse did not inherit the Roth IRA, the full taxes for the 2010 conversion will be due with the 2011 return if client did not elect to report the full conversion on the 2010 taxes. Why would the daughters consider requesting a recharacterized conversion? If their marginal tax rates in retirement will be lower than the rate the client paid or will be paying. Also, if the conversion lost money, they may want to recharacterize all or part of it. But once they do that, they cannot create an inherited Roth again, because an inherited TIRA cannot be converted. Also, if they recharacterize, it will trigger a 2011 RMD for the clients year of death that would not exist if the conversion was retained. The daughters would have to take the balance of the 2011 RMD the client did not take.

Once the decision is made to retain the conversion, the separate accounts should be created for each daughter. They will each be able to use their own life expectancies for their RMDs, the first of which is due no later than 12/31/2012.

With respect to the taxation of their Roth distributions, the Roth is only qualified if the client made his first Roth contribution prior to 2007. Until the 5 year holding period is met, any earnings that are distributed will be taxable, but since earnings will come out last, only a very large distribution would trigger taxes.

Submitted by William Harris on Thu, 2011-04-07 20:23

5 year rule threw a curve ball at me. If we converted $500,000, I assume $250k is the starting basis for each of the beneficiaries going forward?

Submitted by Alan Spross on Thu, 2011-04-07 20:36

Correct, assuming 50-50 beneficairies, they would split the Roth IRA breakdown, ie each would get half the regular contributions if any, each would get half of all the conversion contributions, and each would get half of any earnings. If this was owner’s first Roth of any kind, then I am sure that they would not be pulling out earnings since each beneficiary would have to withdraw 250k before any of their distributions became taxable. As of 1/1/2015 these inherited Roth IRAs would be fully qualified and the earnings would be tax free.

There is NO 5 year conversion holding period because death distributions waive the early withdrawal penalty. But they also need to determine where the taxes due on the conversion will come from unless they were all paid with the 2010 return.

Submitted by William Harris on Thu, 2011-04-07 21:28

Alan,
I’m a little confused. Taxes were paid via estimated taxes in 2010 from another source. There should be none due.

You mention 5 year rule was waived at death, but then stated the inherited IRAs would be fully qualified 1/1/15? Please clarify.

Thanks for all your help! This is my first inherited Roth, want to make sure I get it right.

Submitted by Alan Spross on Thu, 2011-04-07 22:19

If all the taxes were paid in 2010 or by 4/18, then there are no further taxes due on the conversion. Most people planned to defer the taxes to 2011 and 2012.

Regarding the 5 year issues, there are two different 5 year holding periods for a Roth IRA:
1) The conversion holding period to prevent early withdrawal penalty if the conversions are withdrawn. This period ends at death, and in the case of this taxpayer, since he was over 59.5 this holding period never existed in the first place.
2) The holding period measured from the first year of owner’s Roth contribution for earnings to be tax free. This is the one that would be over in 2015 if the 2010 conversion was the owner’s first Roth contribution. If he had earlier contributions, the 5 year period may already be over. Once the 5 year period is over, all earnings are tax free in the case of a deceased owner. You did not say which year he made his first Roth regular contribution or conversion, so the end of that 5 year period needs to be determined. This period continues to run both before and after owner’s death.

Submitted by William Harris on Thu, 2011-04-07 22:29

Thank you. 😀

Submitted by Kathy Patterson on Fri, 2011-04-08 16:34

Additional question: When the daughters pass away, how are their inherited Roths treated when they are inherited by the grandchildren?

Submitted by Alan Spross on Fri, 2011-04-08 16:54

Successor beneficiaries of a non spouse beneficiary must continue the RMD schedule of the original designated beneficiaries. For example, if the RMD divisor for the daughter in their year of death is 14.7, then for the following year it is 13.7, the same as it would have been if the daughters did not pass. Inherited IRAs therefore have a limited life span no matter how many successor beneficiaries inherit the account.

While it is unlikely, if the daughter has elected the 5 year rule, the grandchild would also be obligated to adhere to that rule.

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