Your Options for Using an Inherited Roth IRA

An inherited Roth IRA could provide an unexpected financial windfall. However, since inherited IRAs are subject to very different rules than those applied to original accounts, heirs sometimes struggle to use their funds without being hit by huge penalties.

A recently passed rule, for instance, creates a 10-year withdrawal timeframe for “non-spouse beneficiaries,” including children and grandchildren. This timeframe stipulates that if an heir does not deplete an inherited IRA within 10 years of its receipt, any remaining amount will be taxed at a rate of 50%.

Your options for avoiding penalties depend on your relationship with the deceased account holder, but they could include the following:

A Spousal Transfer

Since spouses are not necessarily required to withdraw IRA funds within 10 years, they may instead treat a Roth IRA inherited from a deceased partner as their own retirement account. This account is subject to the same distribution rules as an ordinary Roth IRA.

However, completing a spousal transfer can be somewhat complex, and you may need an attorney to ensure there is no miscommunication with your bank or the IRS.

Opening an Inherited IRA

Surviving spouses and other beneficiaries can also create inherited IRAs. Funds can be disbursed on any of the following schedules:

  • Life expectancy, with required minimum distributions beginning on the date the original account holder would have turned 73 for surviving spouses or by December 31 of the year following the year of the original account holder’s death for non-spouse beneficiaries.
  • Five-year rule distributions, which eliminate early withdrawal penalties, are not taxable so long as all inherited IRA funds are removed from the account by December 31 of the fifth year following the original account holder’s death.

Taking a Lump Sum Distribution

Surviving spouses and non-spouse beneficiaries can elect to receive a one-time, lump-sum distribution. Withdrawn contributions are not taxed, although earnings may be subject to some taxes if the account was less than five years old at the time of its owner’s death.

The downside to lump sum distributions is that heirs cannot receive the benefit of accrued interest on existing IRA contributions.

Philip J. Kavesh
Nationally recognized attorney helping clients with customized estate planning guidance for over 40 years.
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