Of course, there are many benefits of a Roth IRA. In my opinion, it’s one of the best wealth building investment vehicles available. While you’re living, your Roth IRA is allowed to grow your entire life free of any potential taxes after age 59.5. There will not come a time when you will be required to take distributions. This is unlike a Traditional IRA or 401(k) where you must start taking taxable distributions at some point. But when you die, the Roth IRA inheritance rules change and you need to know how your personal finances could be impacted.
Roth IRA Inheritance Rules for a Non-Spouse
First, non-spouse beneficiaries cannot roll your Roth IRA into their Roth IRA.
Second, a non-spouse must begin taking required minimum distributions over their life expectancy. These distributions are generally tax free. Here’s how the Roth distribution process would work.
Example: Joe Greene has inherited a Roth IRA from his father, Frank. The amount in the Roth account at the end of last year was $100,000. Joe, who is 47 years old, chooses to take the minimum required distribution over his lifetime. To determine the amount he will get, Joe first refers to the Internal Revenue Service Single Life Expectancy Table 1.
Based on his age, Joe selects the life expectancy factor of 37. He divides $100,000 by 37 to arrive at $2,703. He could withdraw more money, but this is the minimum amount he must take this year. Joe will preform this calculation every year. As he gets older, the life expectancy factor will fall.
Now, there is one potential tax implication that Joe must be made aware of. If the Roth IRA was created within 5 years of your death, Joe may have fork over a 10% tax/penalty on certain distributions. Check with a tax attorney or CPA to see if your Roth IRA contains any funds that fall into this category.
Roth IRA Inheritance Rules for a Spouse
Third, if the beneficiary happens to be your spouse, he or she can take over the Roth and treat it as their own. Or, they can wait and start taking distributions on the date YOU would have turned age 70.5.
Now, having said all that, here’s probably the best option, but check with your own financial advisor. Your Roth could be rolled into your spouse’s growing Roth IRA. Then, he or she would not be subjected to any federal income taxes, penalties, or required distributions.
How amazing is that? You would have a serious wealth-producing Roth juggernaut.
And when s/he dies the Roth could be passed to your children, grandchildren, or someone else. Again, the IRS will require that your children take a required minimum non-taxable distribution every year. And while they could take large distributions, the wise strategy would be to just let the inherited Roth IRA grow for as long as possible.
Be aware that the Roth IRA inheritance rules do not allow your children and other non-spousal beneficiaries to make additional contributions to an inherited Roth.
But take a step back and think about the financial impact of a Roth IRA. If you set it up right and let it grow, it has the ability to support your family across three generations — you, your children, and your grandchildren.
Just keep these Roth IRA inheritance rules in mind.