Are Roth IRA Distributions Tax Free For Beneficiaries?

By Beverly DeVeny and Sarah Brenner
Follow Us on Twitter: @theslottreport

This week’s Slott Report Mailbag answers questions on an IRA beneficiary’s tax responsibilities, distribution procedures for employer retirement plans, and tax implications on a Roth IRA beneficiary’s distributions. As always, we recommend that you work with a competent, educated financial advisor to keep your retirement nest egg safe and secure. You can find one in your area here.

1.

If I die and my traditional IRAs go to my heirs, is it distributed immediately? Do the IRA proceeds go directly on top of their income for tax purposes, meaning they would pay their top tax rate? Thanks.

Answer:
Under the tax code, beneficiaries who are named on a beneficiary form can stretch distributions from an inherited IRA over their lifetime. You can find more information on this in IRS Publication 590-B. However, keep in mind that IRA custodians can narrow the options for non-spouse beneficiaries in their IRA document. You should check with your IRA custodian to see what the options are for your IRAs.

2.

Hello,

We wish to convert our 401(k) plan and withhold taxes. My husband is 53. The third-party administrator doesn’t understand the tax law. We provided a W-4 for withholding and they haven’t converted it yet. The management plan states a 60- day rollover option lump sum check can be given. The third-party administrator won’t confirm or send the management rollover paperwork for this.

Is this process correct?

Thanks!

Answer:
Each employer plan will have its own procedures for distributions. Generally the distribution form that the plan provides will have a section where you can elect to have taxes withheld. If you cannot come to an understanding with the plan, you could have the entire amount distributed to you. The plan will do mandatory 20% withholding on the taxable amount of the distribution. You can then keep additional funds if you need them for taxes and roll the balance over to a Roth IRA within 60 days of your receipt of the check from the plan. This will accomplish what you are trying to do in spite of the plan administrator. You should check with a tax advisor to make sure you pay the correct amount of estimated taxes for the year.

3.

Are the proceeds of a Roth IRA tax free to the beneficiaries?

Answer:
It depends on whether or not the 5-year rule has been satisfied. If the decedent had any Roth IRA account for more than five years, then yes, all distributions to the Roth beneficiary are tax free. If the decedent has not had any Roth IRA for more than five years, then distributions of contributions and conversions are tax free to the beneficiary. Any distribution of earnings will be taxable to the beneficiary until the 5-year holding period has been satisfied. The time the beneficiary has held the Roth IRA will be added to the time the decedent had owned the Roth IRA to come up with the five years.