Rules of RMD for inherited Roth Account ( sibling)
I have Roth account(s). My son will inherit these Roth account(s). I am not clear on inherited rules once he becomes owner of these accounts. Does he receive the same benefits of a Roth over his lifetime as I have ( tax free growth with no RMD) ? I have been hearing that he would be required take take full distribution over a 5 year period. All would be tax free but he would have to withdraw all funds within 5 years. Is this correct ? Is there an alternative in keeping the account open and growing over his lifetime as well ? Could use some clarification on this … Thank You John
Permalink Submitted by mk foss on Sat, 2012-04-28 19:37
Currently the default method is to withdraw RMDs from the Roth over the life expectancy of a nonspouse beneficiary. The 5-year rule can be elected – with that rule the account must ber empty at the end of the year that contains the 5 year anniversary of the original owners death. The beneficiary can take 100% of the account in the fifth year with that method.
There have been proposals to put nonspouse beneficiaries on a 5-year schedule but at this point, life expectancy is the default method. As long as the original owner had the Roth for 5 years, all distributions are income tax free.
Permalink Submitted by John Vagianos on Tue, 2012-05-08 19:24
1) If my non-spouse benefactor was to elect that option ( 5 year plan) , how would that be accomplished ?
2) If the non-spouse benefactor chose to continue on the default plan, Could he/she in turn “will” this same Roth account under the “original deceased name” to yet another person at his passing ? Thanks again , John
Permalink Submitted by John Vagianos on Tue, 2012-05-08 19:28
Another question 🙂 If I ( original owner) opened a Roth by converting(rollover) my 401K after age 59 1/2 years of age… Would the 5 year ownership rule still apply ? Thanks John
Permalink Submitted by Alan Spross on Tue, 2012-05-08 20:07
If your first Roth IRA was funded by a post 59.5 conversion, any distributions taken thereafter would be taxable as follows:
1) Up to the amount you converted, no tax and no penalty
2) Additional amounts from earnings would be taxable for the first 5 years only. No penalty
Should you pass, your non spouse beneficiary (eg child or sibling) would have to begin RMDs in the year following your death using their age to determine the RMD divisor. If they did not want to use life expectancy, they could use the 5 year rule, meaning no annual RMD required but the Roth would need to be drained by the end of the 5th year after your year of death. If distributions were limited to annual RMDs, the Roth would be sure to be fully qualified and therefore fully tax free for all beneficiary distributions. However, if the beneficiary drained the account before 5 years passed from the year of your original Roth contribution, any earnings in the account would be taxable.
Note that the 5 year rule for RMDs has nothing to do with the 5 year holding period for the Roth to become qualified and fully tax free. Your designated beneficiary should plan to take out annual life expectancy RMDs, and can always take out more if needed. Planning to use the 5 year rule instead of life expectancy RMDs would destroy the benefit of stretching the IRA and would only be beneficial in certain unique circumstances.
Permalink Submitted by John Vagianos on Tue, 2012-05-08 20:38
So even if I rollover my 401K’s to a Roth IRA after I was 59 1/2 , I still must own the Roth IRA for 5 years before I would receive the tax free benefit of a Roth.
Permalink Submitted by John Vagianos on Tue, 2012-05-08 20:43
Further clarification please: You sited two situations for taxable distributions. The second was confusing to me. What earnings are you referring to ? After five years , no tax ?
Permalink Submitted by Alan Spross on Tue, 2012-05-08 22:09
[quote=”Forbes1960″]So even if I rollover my 401K’s to a Roth IRA after I was 59 1/2 , I still must own the Roth IRA for 5 years before I would receive the tax free benefit of a Roth.[/quote]
Yes, as far as any Roth earnings becoming tax free.
But there is still a benefit if the tax you pay for the conversion is less than the tax you would have paid on TIRA distributions had you not converted.
There may be small benefit if the tax rates are equal because you would have the discretion either to take distributions or not from the Roth. From an unconverted TIRA, there is no choice once you reach 70.5.
The results would be negative if the tax rate you pay for the conversion is higher than what you would have paid later if not converting. If your planning includes benefits for your heirs, you might consider what their tax rates would be instead of yours should they inherit the Roth instead of a taxable TIRA.
Permalink Submitted by Alan Spross on Tue, 2012-05-08 22:19
[quote=”[email protected]“]Further clarification please: You sited two situations for taxable distributions. The second was confusing to me. What earnings are you referring to ? After five years , no tax ?[/quote]
Yes, if the Roth has earnings, those earnings would be tax free after 5 years if you took out earnings. But remember, the earnings come out last. Suppose you converted 50,000 and over 5 years the Roth grew to 60,000. If you took a distribution of less than 50,000 the distribution would still be tax free anytime you distributed it. But once you took out more than 50,000 you are tapping earnings. Earnings would be taxable for the first 5 years and tax free after that. After 5 years and 59.5 the Roth is “qualified” and since it is totally tax free you no longer have to keep track of contributions and earnings to report a distribution.
Heirs use the same 5 years that you do. If you passed 3 years after converting, the heirs would only have to avoid taking out earnings for 2 more years to avoid all taxes.