If you inherit a Roth IRA from your spouse, you'll have several options available for handling the account that other types of beneficiaries don't have.
Unlike traditional individual retirement accounts (IRAs), Roth IRAs are not subject to required minimum distributions (RMDs) during the lifetime of the account owner. A person who inherits a Roth IRA also receives a portion of that tax benefit. The details depend on the IRA beneficiary's relationship to the deceased, with the surviving spouse having the most and best options.
Spouses who inherit their spouse's Roth IRA have several basic options for what to do next. Here's how spouses can choose the best one for their circumstances.
- Spouses who inherit a Roth IRA from their spouse have several options for handling it.
- If they are the sole beneficiaries, spouses can designate themselves as account owners and avoid required minimum distributions during their lifetimes.
- If they are not the sole beneficiary, spouses can roll over their share of the estate into an inherited or beneficiary IRA and take RMDs out of their life expectancy.
- Roth IRAs grow tax-free as long as the money remains in the account.
- Roth distributions are tax-free as long as the account has been open for at least five years.
1. Become an account holder
They can opt to become the account holder which is called Spouse Transfer. In this case, they will not be subject to RMDs during their lifetime but will be their beneficiaries.
To qualify for tax-free withdrawals, the account must meet the five-year holding period rule and the surviving spouse must be at least 59½ years old when they make the withdrawal. It is as if it has been their account before.
Spouse is the only beneficiary who can exercise this option and they are eligible only if they are the sole beneficiary of the account. Otherwise, they have to choose one of the next two options.
2. Roll it over into an inherited IRA
Another option is to roll over inherited Roth IRA assets into an inherited IRA, also known as a beneficiary IRA. In this case, the spouse will have to take distributions sooner or later, either depending on their own life expectancy or if they choose within the 10-year period.
If the beneficiary does not wish to start taking RMDs yet or if their life expectancy would otherwise require them to empty the account in a few years, the 10-year option may make sense. Note that the so-called 10-year rule means withdrawing all money from the account by the end of 10 years and does not include year-by-year RMDs.
For example, assume that Wilma (age 69) inherits a Roth IRA from her late husband, Fred (age 73), and puts money into the inherited IRA account. She could have waited until she was 72 to start taking RMDs. At that point, she'll calculate her RMD using the single life expectancy table found in Publication 590-B of the Internal Revenue Service (IRS). For example, in 2022, a 72-year-old man's single life expectancy would be 17.2 years.
One potential advantage of opening an inherited IRA is that withdrawals are not subject to the 10% early withdrawal penalty unless the five-year rule is satisfied. This can be helpful for surviving spouses under age 59½ who need the money.
This option also gives spouses an advantage over other beneficiaries, in many cases allowing them to spread their RMDs out over more years. In the example above, Wilma would have an RMD of approximately 17.2 years. Also, because she is 69 when she inherits the IRA, she must start taking them three years earlier. Spreading the distribution out over more years gives the money in the account more time to grow tax-free.
In contrast, since the enactment of the Establishment for Every Community for Retirement Enrichment (SECURE) Act in 2019, beneficiaries who are not spouses typically receive accounts by the end of 10 years (or five years, in some cases). needs to be emptied. , The SECURE Act exempts spouses from the 10-year requirement, along with several other groups, classifying them as eligible designated beneficiaries.
3. Cash it out
They can take the money in the form of lump sum distributions. As long as the account meets the five-year rule when the spouse inherits it, the distribution will be tax-free. Choosing this option makes sense for a younger spouse who needs money quickly. The major caveat is that they may miss out on making it available later – and lose the chance for the money to grow tax-free.
The new SECURE Act 2.0 raised the age for taking RMDs from eligible retirement accounts. If you turn 73 on or after January 1, 2023, you should start taking them on April 1. Anyone who is 72 years old between January 1, 2020, and December 31, 2022, should take it at the same age.
How a Roth IRA inherited from a spouse is taxed
Roth IRAs grow tax-free as long as the money remains in the account. This is true whether you are a spouse or not (and is one of the attractive features of using a Roth IRA for estate-planning purposes).
Distributions of the original account owner's contributions are not taxed (because they were made with after-tax dollars), and distributions of account income are taxable only if the account does not meet the five-year rule, As mentioned above. The 10% tax on early distributions applies only to IRAs for which a spouse has designated himself or herself as the account owner.
Does the IRA owner have to name his or her spouse as the beneficiary?
No, says the IRS A A beneficiary can be “any person or entity that the owner chooses to receive the benefits.” It can be a relative who is not a spouse, a friend, a trust, an estate of the account owner, or a charity. An IRA can also have multiple beneficiaries.
How does the IRS define ‘spouse'?
For federal tax purposes, a spouse is “a person who is legally married to another person.” Legally married means that the marriage is “recognized by the state, possession, or territory of the United States in which the marriage was solemnized.” People married in a foreign jurisdiction are considered married for federal tax purposes “if the relationship would be recognized as a marriage under the laws of at least one state, possession, or territory of the United States.” Both of those definitions would apply equally to opposite-sex and same-sex marriages. The law does not recognize as persons husband and wife in a registered domestic partnership, civil union, or other similar formal relationship “not regarded as a marriage under the law of the state, possession, or territory of the United States where this kind of relationship had been entered into.”
What happens if you don't take the RMD?
Taxpayers who fail to take their RMDs are subject to the IRS “Excess Accumulation Penalty”. It is taxed at 50% on the difference between the amount that the individual takes as RMD and the amount (if any) taken by him. The IRS may waive all or part of the penalty if “you can show that any shortfall in the amount of the distribution was due to reasonable error and that you are taking reasonable steps to correct the shortfall.” The new SAFE Act 2.0 reduced the penalty to 25% and it begins in the 2023 tax year.
Spouses have more flexibility when they receive a Roth IRA than other beneficiaries, and they may be able to avoid RMDs during their lifetimes, keeping the account intact for the next generation. As is probably clear from the discussion above, the rules on inherited IRAs—both Roth and traditional—are devilishly complicated. They're subject to change by Congress at any time, so it may be worth it to pay for expert professional guidance if you've got an IRA and substantial money is involved.