Roth conversion and inheritance
If an elderly person in their late 80’s makes a series of Roth conversation but dies before the 5 years for the first conversion are complete, what is the impact on their 3 adult children in their early 60’s inheriting the Roth conversion IRA?
- Can they allow the clock to continue ticking to complete the 5 years for each conversation before they have to take the money out tax free (but within the 10 year IRS requirement)?
- Does the 5 year rule apply to the amount converted and the earnings or just the earnings?
Permalink Submitted by Alan - IRA critic on Tue, 2024-12-17 15:17
Assuming that these conversions were the first contributions the person ever made to a Roth IRA, the beneficiaries could still withdraw the entire amounts converted without tax or penalty. There would not be much in earnings in the inherited Roth IRAs, but if a beneficiary withdrew more than the contributions, the amount of earnings would be subject to tax. After 5 years from the year of the first Roth conversion, the inherited Roths would be qualified and entirely tax free including the gains. Therefore, the 5 years only applies to distributions of gains, and they come out last.
Example: 120,000 converted by owner over a period of years with first conversion done in 2021, and the Roth is worth 135,000 when owner passes. Each inherited Roth for a 1/3 beneficiary contains 45,000, of which 40,000 is conversion contributions. A beneficiary can withdraw up to 40,000 with no tax, and after 2025 can also withdraw the 5000 of gains and all additional gains tax free.
The beneficiaries will have no annual RMDs but must drain the inherited Roths by the end of the 10th year.
Permalink Submitted by Nandani Original on Tue, 2024-12-17 15:50
Thank you! That is very helpful.
Permalink Submitted by Nandani Original on Tue, 2024-12-17 20:13
Sorry, actually I had a follow up question regarding your first point “assuming these were the first contributions this person ever made to a Roth IRA.” These would be the first conversions from an traditional IRA that she’s making. She already has a Roth IRA into which had contributed (not converted) from a long time ago and so has met the 5 year rule by long stretch. I thought the conversion is treated separately, and the clock resets for each conversion. Could you please clarify?