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You can inherit a Roth individual retirement account (IRA) and avoid a lengthy court process known as probate as long as the person who passed away listed you as a beneficiary and you are still alive. The distribution rules for beneficiaries can get complicated and depend on two key factors:
When you inherit a Roth IRA, the money you receive gets the same tax-advantaged treatment as the original account. Because the money was contributed on an after-tax basis, you can withdraw the contributions at any time without paying tax or penalty.
The five-year rule states that as long as the account was opened at least five years ago, withdrawals of earnings are tax-free. Earnings withdrawn from Roth IRAs less than five years old are subject to income tax at your ordinary tax rate, plus a penalty.
The passage of the SECURE Act changed how the distribution time period is determined for an inherited IRA. If your loved one died in 2020 or later, then you don't have to take required minimum distributions, or RMDs, but you need to withdraw the entire amount of the IRA within 10 years.
The new law prevents you from stretching out the distributions over your lifetime, which enables you to maximize the account's tax-free growth. However, the new law also creates a category of beneficiaries called "eligible designated beneficiaries" who are still allowed to stretch distributions over their life expectancies. You qualify as an eligible designated beneficiary if:
Under the old rules, which apply if your loved one passed away in 2019 or earlier, you have to take RMDs when you inherit a Roth IRA from someone who wasn't your spouse. You can stretch distributions over your lifetime using an IRS uniform life expectancy table to estimate your remaining lifespan based on your age.
For example, someone who is 40 years old in 2022 could expect to live another 45.7 years. So a 40-year-old with a $1 million inherited Roth IRA would have an RMD of $21,881, which is equal to $1 million divided by 45.7.
Your options for inheriting a Roth IRA are different when the original account owner was your spouse. Here are your alternatives as a spousal beneficiary:
A Roth IRA inherited from a parent is treated the same as a Roth IRA inherited from any other non-spouse. Your options are relatively limited because you aren't allowed to treat the account as if it were originally your own.
If you inherit a Roth IRA from a parent or non-spouse who died in 2020 or later, you can:
If you inherited a Roth IRA from a parent or non-spouse who died in 2019 or earlier, you can:
Regardless of when your loved one died, you have the option of taking a lump-sum distribution. You do not pay income tax or a penalty regardless of your age provided the IRA has been open for at least five years.
Inheriting a Roth IRA and leaving assets in the account as long as you can has the major advantage of allowing the assets to continue to grow tax-free. Gains held in an IRA are not taxed no matter how much the account increases, which is one of the biggest advantages of Roth IRAs.
It's essential that you understand and follow all the rules, though. If you fail to annually take enough money out of the account as the IRS requires, you could pay a penalty equivalent to 50% of the amount you should have withdrawn for the year.
Before you make any big decisions about your inherited Roth IRA, consider consulting with a tax advisor to make sure you comply with all the rules and maximize the growth of the money you've received.
