@mjc4maureen wrote:
Got it. Thanks. You possess the knowledge I don't have. I really appreciate your sharing. Three more questions if I may ask.
(1) Roth Inherited IRA - is tax free as long as fund is there longer than 5 years as I understand. So if my beneficiary withdraws all of it once on the 10th year, then it should pass 5 years mark therefore, all is tax free. In other words, no income tax needs to be reported, right?
OK, let me take one more stab at this.
The short answer is the 5 year clock only runs once. It doesn't restart when you die, but it must run at least once. If you die and the account is open less than 5 years, your beneficiaries will pay income tax (but not the 10% penalty) if they withdraw earnings before the 5 years is satisfied. They can withdraw regular contributions and conversion contributions without tax or penalty.
If you met the five year rule before you died, then all withdrawals by your beneficiaries are tax-free. The clock does not start over.
Here is the technical explanation.
Roth withdrawals can be qualified or unqualified, and they can be early or not. These are two different things. A withdrawal is not qualified if it is within the 5 year clock (even if the owner is over age 59-1/2), and there is a separate clock on each conversion. A withdrawal is early if the owner is under age 59-1/2, except that beneficiaries are exempt from the 10% penalty.
- A withdrawal of contributions is never taxed.
- A withdrawal of a conversion that is not qualified (less than 5 years since the conversion) is subject to the 10% early penalty but not regular income tax.
- A withdrawal of earnings that is not qualified (account open less than 5 years) is subject to the 10% penalty and regular income tax.
Again, remember the account has a 5 year clock and each conversion has a separate 5 year clock. And also remember that a beneficiary does not pay the 10% penalty but they can still be subject to the regular income tax on non-qualified withdrawals.
So if the account was open less than 5 years, the beneficiary will pay regular income tax if they withdraw earnings before the original owner's 5 year clock is satisfied. They don't pay tax on the contributions or on conversion contributions (because even if a conversion contribution is less than 5 years for its own clock, you don't pay income tax on non-qualified withdrawals of conversions, only the penalty, and beneficiaries are exempt from the penalty.)
