ROTH transferred into VA, non-spouse inherited
I am seeking guidance on this question:
A non-spousal beneficiary inherits a ROTH IRA that had been transferred into a variable annuity account less than 1year ago. There is appreciation in the new VA account. I have reason to believe that the ROTH IRA was a converted Traditional IRA approximately 1 year prior to the funds being transferred over into the new variable annuity account.
Were the assets to be in a ROTH IRA regular brokerage account, the mandatory distributions would be free of tax to the non-spouse beneficiary (except, possibly,in the event of the ROTH being established less than 5 yrs ago).
However, being that the ROTH IRA assets are now in a variable annuity contract, my understanding is that ALL dollar distributions from the account are fully taxed at ordinary income tax rates. In other words, the benefits of “tax free distributions from the ROTH” have been lost due to the ROTH being transferred over into a variable annuity contract. Can you please confirm my understanding.
Permalink Submitted by Alan Spross on Fri, 2011-05-27 19:18
The key issue here is whether the VA is a Roth IRA VA or a non qualified VA.
1) If the VA is non qualified, then a Roth distribution occurred when the Roth was distributed to fund the VA purchase. Like you said, if there were earnings in the inherited Roth and the Roth was started by the owner within the last 5 years, the earnings would be taxable and the Roth distribution would be reported on Form 8606. The non qualified VA would be treated like any other VA for taxation of withdrawals, ie earnings come out first and are taxable. There could also be an early withdrawal penalty because the VA would be owned by the beneficiary, not inherited.
2) Hopefully, the inherited Roth was transferred to an inherited Roth VA. In that case, the Roth taxation rules trump annuity tax rules. If the Roth VA is distributed before the Roth is qualified (5 years), earnings would be taxable as in 1) above for Roth distributions under the ordering rules where earnings come out last. However, if the 5 year holding period has been met, then all Roth VA distributions are tax free. RMD distributions must begin in the year after owner’s death, but they would be tax free, coming first from contributions to the Roth. By the time earnings were tapped the 5 year holding period would have been met.
Permalink Submitted by Catherine Turner on Fri, 2011-05-27 19:51
Neither is the case. I must have confused you. The owner had a Trad IRA, then converted it to a ROTH IRA (in a std brokerage account) …which, yes, had to pay taxes during that tax year, then with the recommendation/help of a broker, transferred the funds into a VA- still labled as a ROTH IRA. NOW
Permalink Submitted by Catherine Turner on Fri, 2011-05-27 20:21
I just spoke with a JD and CPA who specialize in this area……… the properly registered ROTH IRA maintains its form as a ROTH IRA – with the inherent assets invested in a VA. all non-spousal beneficiary distribution regulations follow suit to those of a ROTH IRA. Thus, just because the assets are parked in a VA, distributions do not lose their tax free benefit (pending finding out when the original ROTH IRA was established). I was glad to find that out!
Permalink Submitted by Alan Spross on Fri, 2011-05-27 20:42
Right.
As I indicated in 2) above, the Roth taxation rules trump the annuity rules as long as the account was a Roth IRA VA, and not a non qualified VA.
In my opening sentenc in 2), I might have been clearer that whether the decedent or the beneficiary was the one that did the tranfer to the VA, as long as the VA was held in a Roth account, the Roth tax rules will apply to all distributions including beneficiary RMDs.
Permalink Submitted by Catherine Turner on Fri, 2011-05-27 20:50
as always, thanks for your expeditious and full replay! Enjoy your holiday weekend!