Inherited Roth & Traditional IRAs

[sfstevo]

Hello Experts! I inherited two IRAs, a Roth and a traditional IRA. I am the sole beneficiary and those accounts moved by the custodian to my account earlier in 2022. We both had the same financial institution. I have been doing much research on how to handle proper distributions, correct deadlines, and the reporting for tax purposes. Some background: these IRAs are non-spousal. We were unmarried partners.

Following is what I gathered from the IRS and I'd like to know if I'm on the right track.

1) I'm considered an "eligible designated beneficiary" (EDB), other than a spouse, and an individual not more than 10 years younger than IRA owner. In this case can I treat the Trad IRA as my own and begin RMDs at 72?

2) I was advised to withdraw the Roth IRA first, as distributions are considered qualified and generally tax-free. Is this your understanding? 

3) If there are RMDs, custodian must report amount or offer to calculate RMD before Jan 31 of the year RMD is required. Is this correct?

I think those are some of the areas I covered, that I didn't completely understand. I appreciate your expertise so that I can follow the tax codes without triggering an event. Thank you.  

[Joe_D-CPA-PFS-CFP · Accepted solution]

Hello sfstevo,

Thank you for the question. It looks like you inherited a ROTH and a Traditional IRA and your custodian has transferred both of them into separate beneficiary IRAs because you were the sole designated (non-spouse) eligible beneficiary on each IRA. I am also assuming that you both are under the age required for mandatory RMD's and that the decedent died in 2022.

As a general statement, withdrawals taken from a Traditional IRA that has been inherited are only subject to the early withdrawal penalty if the funds from the deceased's IRA are transferred directly into the beneficiary's own IRA. Early withdrawal penalties never apply to lump sum distributions or withdrawals from "Inherited IRAs." Therefore, since you created a beneficiary IRA the withdrawals will not be subject to the early withdrawal penalty. In your case, being a non-spouse beneficiary you cannot roll an inherited IRA into your own IRA anyway.

As a general statement, subject to the eligible withdrawal options and depending on the beneficiary type,  taking withdrawals more than the RMD required from the ROTH IRA first, is a personal preference. From a tax liability standpoint, you might consider taking ROTH distributions first, but from an investment/growth standpoint, leaving as much money in the ROTH to grow tax-free for as many years as possible might be a better choice, especially if you choose the 10 year rule.

Distribution of the account is mandatory for non-spouse designated beneficiaries of inherited ROTH IRAs  and you have 10 years to draw down the entire amount. If you are eligible and chose to draw it out over your life expectancy, distributions must begin no later than 12/31 of the year following the year of death. These distributions are spread over the beneficiary's single life expectancy, a table that has been updated recently. Here is the IRS site for the tables. Eligible designated beneficiaries have two options.

Whether or not the distributions from the ROTH IRA are taxable depend on the following:

• Distribution of all amounts except earnings: Tax Free and penalty free. These amounts are distributed first.
• Distributions of earnings.  Penalty free. Taxable only if it has been less than 5-years since the Roth IRA owner funded the Roth IRA. You count the 5-year period from the owner- the beneficiary inherits the 5-year start date from the Roth IRA owner.

In regard to the IRA withdrawal rules:

• for a designated beneficiary, the 10-year rule applies. Distributions are optional until the 10^th year, when the entire balance must be distributed.
• for an eligible designated beneficiary, you can choose between
  1. the 10-year rule and
  2. taking distributions over your life expectancy, beginning by 12/31 of the year that follows the year in which the owner died.

You would be an eligible designated beneficiary, if at the time of the Roth IRA owner’s death, you are: Disabled, chronically ill, or not more than 10-years younger than the Roth IRA owner.

You will receive a Form 5498 at the end of every year from the custodian of the IRAs with the end of year balance to apply the life expectancy table factor to calculate the required minimum distribution. This is the official balance used by the tables to calculate the correct minimum distribution. Even though the custodian provides the Form 5498 and also may calculate the RMD, it is still your responsibility to make the correct and timely distribution each year.

[ES CPA · Accepted solution]

@sfstevo   First, let me extend my condolences on the loss of your partner.  Second, let me commend you on the great job you did researching your concerns and getting answers!

1. Based on the fact pattern you stated, you would be considered to be an eligible designated beneficiary and can use your own life expectancy to calculate RMDs.

2. As to the timing of Roth vs Traditional IRA's that would depend on the other income on your return and the return the investment is earning.  As no deduction was received when funds were placed in a Roth account, they are not taxed when they are taken out.  Earnings on Roth accounts can also be taken out tax free if certain conditions are met.  The IRS considers a withdrawal to be qualified if you’ve had a Roth IRA for at least five years and the withdrawal is taken under one of these categories:

• When you’re age 59½ or older
• Because you have a permanent disability
• By a beneficiary or your estate after your death
• To buy, build, or rebuild your first home (a $10,000 lifetime maximum applies)

3. Account owners are responsible to calculate their RMD.  Generally, a RMD is calculated for each account by dividing the prior December 31 balance of that IRA or retirement plan account by a life expectancy factor that  the IRS publishes in tables in IRS Publication 590b .  Your custodian can certainly help with the process.  In the case of a 401K, the employer is responsible for calculating the RMD.

[sfstevo]

Thank you Joe! We both are a year apart in age at 63, so well under the mandatory 72. Vanguard did a great job of keeping my IRAs separated and the inherited IRAs are designated as such with the corresponding balances. I will keep your response, as I know the rules can be very complex and don't need any penalties for inadvertently making a wrong move. Fortunately, i'm over 59 1/2 and beyond the 10% early withdrawal penalty.  Thanks again for your help. 

[sfstevo]

Thank you ES! I was encouraged by my individual investor group to get ahead of this before I must begin taking distributions, and the publication 590 is full of details about the handling of retirement account distributions. Plus I did more reading from specific tax websites that were very insightful. I will keep your response and refer to it when I begin the distribution process. Fortunately, I have some time to make decisions.  Thanks again! Best for the holidays. 

[Joe_D-CPA-PFS-CFP · Accepted solution]

If you like my answer, consider choosing it as the best answer.