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Retirement > 401(k)s & IRAs
Inheriting an IRA
May 10, 2000: 10:48 a.m. ET

Seem like a simple process? Beware the numerous tax consequences
By Ed Slott
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NEW YORK (CNNfn) - When someone called last week and said that he inherited a $4,400 Roth IRA from his mother and had a few questions, I did not think that this would be too involved: the Roth he inherited was not from a Roth conversion in which money from a regular (traditional) IRA was converted to a Roth IRA.

No, this was much simpler than that.

graphicAll his mother had was the plain vanilla $2,000 per year she contributed to a Roth IRA in 1998 and 1999 and the remaining $400 was interest earned for the short time she had it before she died in April 2000. Even though he only inherited a Roth worth $4,400, there were numerous tax issues that had to be addressed, especially since the beneficiary was not a spouse. It immediately struck me that this is no simple situation.

Here are some of the questions he asked, followed by my responses.




Ed Slott's irahelp.com





Do I simply transfer this to my own Roth IRA?

No. You cannot roll over an inherited Roth IRA to your own. Only a spouse can do that. A non-spouse beneficiary, such as a child, can never roll over to his own Roth IRA. The account will remain an inherited Roth IRA and that is how you will withdraw from it.

Do I retitle the account in my name?

No. You cannot do that or else it will be treated as a complete distribution of the account. You must keep the deceased Roth IRA owner's name on the account forever and add your name as the beneficiary.

The account title of your inherited Roth IRA should read:

"Mary Smith (deceased April 10, 2000) Roth IRA, For the Benefit of Jim Smith, Jr. (beneficiary)."

Jim Jr. is the son/beneficiary and the account should be under his Social Security number, since he will be the one making withdrawals.

Can I continue to contribute to the inherited Roth IRA?

No. As a non-spouse beneficiary, you can never contribute additional funds to your inherited Roth IRA.

Well, if I cannot contribute, can I just let the money sit there to grow tax-free?

No. A non-spouse beneficiary is subject to required minimum distributions even though a Roth IRA owner is never required to withdraw from his or her Roth IRA. This is an inherited Roth and you must begin taking distributions.

When must distributions begin? Can I wait 5 years?

You could, but if you chose the 5-year rule, the entire Roth IRA would have to be distributed by the end of the fifth year after the year of death, ending the tax-free build-up forever. The better option is to withdraw over your lifetime. This allows the inherited Roth IRA to grow tax-free for the longest possible time. You elect this method by taking your first required distribution no later than Dec. 31 of the year following the year of death. In this case, the first distribution would have to be made by Dec. 31, 2001, since your mother died in 2000. If you do not withdraw by the end of the year after the year of death, you automatically default to the 5-year rule.

What if I never bother with the required distributions? If the distributions are tax-free anyway, why should the IRS care whether I take them or not?

They do care. If you do not take your required minimum distributions, you will be hit with a 50 percent penalty on the amount you should have withdrawn, but did not. Even though the withdrawal would have been tax free, the 50 percent penalty still applies.

This is getting too complicated. What if I just take all the money out now? Isn't it all tax-free anyway?

No. In order for the entire balance, the $4,400, to be tax free, the account has to be held for at least 5 years. Since your mother opened the account in 1998, the 5-year holding period began on Jan. 1, 1998. You would have to wait until Jan. 1, 2003 to be able to withdraw the entire balance in the account tax-free. If you withdraw the $4,400 right now (in 2000), the $4,000 of original contributions would be tax free, but the $400 in earnings would be taxable.

If I withdraw the entire balance, will I have to pay a 10% penalty since I am under 59-1/2 years old?

No. The 10% penalty does not apply to IRA beneficiaries, regardless of their age.

How do I know how much to withdraw?

Withdrawals are based on your life expectancy according to the tables in IRS Publication 590. You look up your age in the year after the year of death and find the life expectancy factor in years. You divide the balance of the inherited IRA as of the end of the prior year. In your case, since your mother died in 2000, you would use the Dec. 31, 2000 balance and use the age you will turn on your birthday in 2001.There is nothing easy about inheriting a Roth IRA.

As you can see from this actual scenario, even a plain vanilla Roth IRA is sprinkled with numerous tax issues to address. If you are in this situation, seek a competent IRA tax adviser. Back to top

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.