Inherited Roth IRA 5 year clock

Submitted by Sten Lindquist on Fri, 2023-02-03 17:28

Client has had their own Roth IRA for over 5 years and is 59.5 but inherited an IRA from his sister who started it just 3 years ago. Does he need to separately meet the 5 year requirement for the inherited Roth?



Submitted by Alan - IRA critic on Fri, 2023-02-03 17:46

  • Yes. The 5 year holding period for the inherited IRA starts with the first year of sister’s contribution and continues to run after sister’s death. For example, if her first contribution was for 2020 then the inherited Roth will not be qualified until 1/1/2025. Until that time, any distributions need to be reported on Form 8606, and that requires knowing her Roth regular contribution and/or conversion basis. This info if often very difficult to obtain for inherited Roth beneficiaries. Therefore, since there are no annual RMDs unless client is an EDB (eg not more than 10 years younger than sister), client can wait to take the first distribution after the 5 years is complete and will not have to research the correct basis, since after the Roth is qualified it is totally tax free and distributions do not have to be reported on Form 8606, only on line 4a of Form 1040.
  • To clarify, the inherited Roth is totally separate from client’s own Roth in all respects. If client is a 10 year rule beneficiary there are no annual RMDs, and waiting until year 10 to drain the account allows more time to generate tax free gains in the inherited Roth IRA. 
  • To determine the year of first contribution, perhaps sister left some Roth IRA statements, retained Form 5498, or provided into to her tax preparer about her contributions (year and amount).  Client just needs to determine what that year was unless he plans not to touch the account for 5 more years when it will surely be qualified. But if client is an EDB annual RMDs will be required and client will need to determine the basis info.

Submitted by ssel on Sat, 2023-02-04 05:01

“after the Roth is qualified it is totally tax free and distributions do not have to be reported on Form 8606, only on line 4a of Form 1040”

Looking at Form 8606, it seems to say Part III is needed for any Roth IRA distribution, with no exception listed just because the Roth IRA is qualified.  If it’s qualified you get to stop at line 22.  Is this correct, that you still need to track your contribution basis on Form 8606 even after the Roth IRA is qualified?  It sounds useless and doesn’t seem to match what Alan said above, but I can’t find where it says you can skip the form entirely. 

Submitted by David Mertz on Sat, 2023-02-04 13:46

  • The instructions for Part III are rather vague with respect to this.  The instructions say to use Part III to calculate the taxable part of a Roth IRA distribution.  Because qualified distributions are already known to be nontaxable, there is no need to calculate the taxable part, so are not reportable on Part III.  Additionally, the way Part III works is to treat as taxable any earnings distributed that are not used for a qualified first-home purchase when they actually are not taxable if your Roth IRAs are qualified.  This all leads to the conclusion that once your Roth IRAs are qualified you are no longer to prepare Part III.
  • You still might want to track your remaining basis as would have been calculated on Part III if you are ever concerned that you would have unrecoverable basis that you could claim as a miscellaneous deduction after such deductions become permissible again after 2025, as the tax code currently dictates.

Submitted by Alan - IRA critic on Sat, 2023-02-04 15:01

Another outlier under which you would still track your basis post qualification is the situation where your Roth is qualified due to disability but there is a slight chance that you could recover enough to lose disability qualification before age 59.5. If that were to occur your Roth would again become non qualified and you would need to report distributions on Form 8606 showing your basis. Again, this is an outlier.

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