Inherited Roth IRA ordering rules and taxation on earnings.
Father, age 76 passed away in 2023. Had 10 Roth IRA accounts all from conversions. 5 of the Roth IRA’s were from conversions that took place 5+ years ago and 5 were from conversions in the last 5 years. If the beneficiary wants to combine all the Roth IRA’s into 1 and take out over 10 years, are the earnings from the most recent 5 year conversions taxable? What are best practices when inherited Roth IRA’s? In other words, if the most recent conversions earnings are taxable, wouldn’t it make sense just to cash those out since they are no longer tax-free and keep the other conversions (5+ years) in an inherited Roth and distribute over 10 years?
Permalink Submitted by Alan - IRA critic on Tue, 2023-12-26 18:23
It’s much simpler than that. SInce all of decedent’s Roth IRAs are treated as only one combined account, because at least one of them is over 5 years, all the inherited Roth IRAs are treated as qualified upon father’s death. Any and all distributions will be tax free, and reported only on line 4a of Form 1040. The 10 year rule applies with no annual RMDs in years 1-9, allowing the inherited Roths to be left alone for 10 years to generate tax free gains. These can also be directly transferred into a single inherited Roth IRA if desired.
Permalink Submitted by Robert Witt on Wed, 2023-12-27 15:54
I stand corrected. Although there are 10 accounts, the first conversion was done in 2020. Am I correct that these can be combined into 1 account and rolled into an inherited IRA and as long as they beneficiary holds the account through 2025 (i.e. 5 years combined), then they earnings will be tax free?
Permalink Submitted by Alan - IRA critic on Wed, 2023-12-27 20:48
Yes. If the first contribution of any type to a Roth IRA was in 2020, the inherited Roth IRAs will not be qualified until 2025. Any distributions prior to 2025 will have to be reported on Form 8606 under the Roth IRA ordering rules, which will require knowing the total conversion basis of all conversions. Most likely, a large portion of these inherited Roth IRAs are conversion basis. They can be combined at anytime without any effect on the ordering rules.