Inherited Roth and the Five Year Rule

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jackrabbit14
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Inherited Roth and the Five Year Rule

Post by jackrabbit14 »

I have a Roth at Schwab that is older than five years.

My wife has a Roth at Schwab, but it is NOT older than five years.

I'm trying to figure out her options with respect to her inheriting my IRA if I die before her IRA is five years old. She is the sole primary beneficiary of my Roth.

I understand the 'lump sum', and opening the 'inherited IRA' options.

The other options I have seen is "Designate yourself as the owner of the account or transfer the account's assets into your own Roth IRA".

Now on to my questions:

'Designating yourself as the owner of the account': I take that to mean that my wife would contact Schwab, notify them of my death and have my name replaced with hers. She would now have two Roth IRAs, one of them older than five years (mine), and one not. Correct?

If, instead, she transferred my account assets into her Roth, I would assume that 'aging' of her account does not change. That is, it still is restricted to her original five year start date. Correct?
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arcticpineapplecorp.
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Re: Inherited Roth and the Five Year Rule

Post by arcticpineapplecorp. »

What did schwab say when you asked them?
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
Alan S.
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Re: Inherited Roth and the Five Year Rule

Post by Alan S. »

arcticpineapplecorp. wrote: Thu Oct 21, 2021 8:54 pm What did schwab say when you asked them?
Let me guess - "see your tax advisor".

It's complex as you will see in the following post.
Last edited by Alan S. on Thu Oct 21, 2021 9:13 pm, edited 1 time in total.
Alan S.
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Re: Inherited Roth and the Five Year Rule

Post by Alan S. »

jackrabbit14 wrote: Thu Oct 21, 2021 3:14 pm I have a Roth at Schwab that is older than five years.

My wife has a Roth at Schwab, but it is NOT older than five years.

I'm trying to figure out her options with respect to her inheriting my IRA if I die before her IRA is five years old. She is the sole primary beneficiary of my Roth.

I understand the 'lump sum', and opening the 'inherited IRA' options.

The other options I have seen is "Designate yourself as the owner of the account or transfer the account's assets into your own Roth IRA".

Now on to my questions:

'Designating yourself as the owner of the account': I take that to mean that my wife would contact Schwab, notify them of my death and have my name replaced with hers. She would now have two Roth IRAs, one of them older than five years (mine), and one not. Correct?

If, instead, she transferred my account assets into her Roth, I would assume that 'aging' of her account does not change. That is, it still is restricted to her original five year start date. Correct?
No. If she would benefit by assuming ownership, she would advise Schwab and submit a copy of the death Cert and related information on herself. Schwab would then transfer the inherited Roth into either a separate Roth account she owns or her existing Roth IRA. Her 5 year holding period starts with the older of the year of your first Roth contribution or her first Roth contribution. The Roth basis of both is integrated. If her existing Roth is qualified then her total combined Roth is also qualified.

She also has the option of continuing the inherited Roth retitled as such. Since your Roth has met the 5 year holding requirement, your death would make this inherited Roth qualified and fully tax free. While she could tap the entire inherited Roth tax free right away, continuing as inherited also means that she will be subject to annual RMDs starting in the year you would have reached age 72. She may not want or need these RMDs which deplete the account.

As you can see, this situation presents various options which depend on several variables such as whether she will need distributions or not, and what her age is when she inherits.

With the several variables, we could narrow the options down if we knew her present age and when she would be likely to need Roth distributions.
Z3roCool
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Re: Inherited Roth and the Five Year Rule

Post by Z3roCool »

While she could tap the entire inherited Roth tax free right away, continuing as inherited also means that she will be subject to annual RMDs starting in the year you would have reached age 72. She may not want or need these RMDs which deplete the account.
Is there a RMD with (inherited or not) Roth IRAs? I was always under the assumption that RMD are only for for tIRAs and 401ks.
cbeck
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Re: Inherited Roth and the Five Year Rule

Post by cbeck »

If she took ownership of the Roth that she inherits, she could always withdraw contributions up to her total Roth basis, which comprises her contributions and conversions older than five years as well as your contributions and conversions older than five years. She would not have taxes or penalties to pay and she would not be forced to exhaust the account earlier than necessary.
Alan S.
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Re: Inherited Roth and the Five Year Rule

Post by Alan S. »

Z3roCool wrote: Thu Oct 21, 2021 11:16 pm
While she could tap the entire inherited Roth tax free right away, continuing as inherited also means that she will be subject to annual RMDs starting in the year you would have reached age 72. She may not want or need these RMDs which deplete the account.
Is there a RMD with (inherited or not) Roth IRAs? I was always under the assumption that RMD are only for for tIRAs and 401ks.
RMDs are required for inherited Roth IRAs, just not for owned Roth IRAs.
Topic Author
jackrabbit14
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Re: Inherited Roth and the Five Year Rule

Post by jackrabbit14 »

Thanks to all for the input.
cbeck
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Re: Inherited Roth and the Five Year Rule

Post by cbeck »

Here's a question. Since the Inherited IRA has the advantage that the spousal heir can continue the distributions of the original owner without penalties, but the disadvantage that the whole account must be exhausted within ten years, could the original owner separate his IRA into two IRAS, even at the same brokerage? Then the inheriting spouse could have the option to receive one of the IRAs as owner and the other as beneficiary of the now Inherited IRA. Or the heir could elect to accept both as owner or both as beneficiary depending on how close she is to age 59 1/2 when the original owner dies. Receiving one of each would allow greater preservation of the assets. If the owned IRA were to become exhausted at some later time she could always elect 72(t) distributions at that time.

I asked a Vanguard CSR if multiple IRA accounts with the same owner are permitted and he said that there is no limit.

So, is this possible?
Alan S.
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Re: Inherited Roth and the Five Year Rule

Post by Alan S. »

cbeck wrote: Sun Oct 24, 2021 8:51 pm Here's a question. Since the Inherited IRA has the advantage that the spousal heir can continue the distributions of the original owner without penalties, but the disadvantage that the whole account must be exhausted within ten years, could the original owner separate his IRA into two IRAS, even at the same brokerage? Then the inheriting spouse could have the option to receive one of the IRAs as owner and the other as beneficiary of the now Inherited IRA. Or the heir could elect to accept both as owner or both as beneficiary depending on how close she is to age 59 1/2 when the original owner dies. Receiving one of each would allow greater preservation of the assets. If the owned IRA were to become exhausted at some later time she could always elect 72(t) distributions at that time.

I asked a Vanguard CSR if multiple IRA accounts with the same owner are permitted and he said that there is no limit.

So, is this possible?
Much of it is possible, but some of it is not necessary.

A spousal beneficiary is not subject to the 10 year rule. They are "EDBs" (eligible designated beneficiaries) and can stretch an inherited IRA as in pre Secure Act days. They can also enter the RMD table each year rather than reducing the prior year divisor by 1.0 each year, and sole beneficiaries do not have to start inherited IRA RMDs until the year deceased spouse would have reached 72. These latter two rules reduce rapid reduction of the inherited IRA via beneficiary RMDs.

However, the spousal beneficiary can also choose to do the spousal rollover of any portion of the inherited IRA, and do so several times. For example, roll over 30% to start with and when they get closer to 59.5 roll over another 30% or any other amount once they are sure that the penalty free inherited IRA amount remaining will be enough. For an inherited Roth IRA (the OP question), since regular contributions and aged conversions come out tax and penalty free anyway, more could be rolled over, and the more rolled over to an owned Roth, the less is left subject to beneficiary RMDs.

Since the beneficiary can make the partial spousal rollover decision, there is no need for the deceased spouse to create additional IRA accounts. The beneficiary starts with all them as inherited, and can make the spousal rollover decision themselves as needed.
cbeck
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Re: Inherited Roth and the Five Year Rule

Post by cbeck »

Alan S. wrote: Sun Oct 24, 2021 10:52 pm
cbeck wrote: Sun Oct 24, 2021 8:51 pm Here's a question. Since the Inherited IRA has the advantage that the spousal heir can continue the distributions of the original owner without penalties, but the disadvantage that the whole account must be exhausted within ten years, could the original owner separate his IRA into two IRAS, even at the same brokerage? Then the inheriting spouse could have the option to receive one of the IRAs as owner and the other as beneficiary of the now Inherited IRA. Or the heir could elect to accept both as owner or both as beneficiary depending on how close she is to age 59 1/2 when the original owner dies. Receiving one of each would allow greater preservation of the assets. If the owned IRA were to become exhausted at some later time she could always elect 72(t) distributions at that time.

I asked a Vanguard CSR if multiple IRA accounts with the same owner are permitted and he said that there is no limit.

So, is this possible?
Much of it is possible, but some of it is not necessary.

A spousal beneficiary is not subject to the 10 year rule. They are "EDBs" (eligible designated beneficiaries) and can stretch an inherited IRA as in pre Secure Act days. They can also enter the RMD table each year rather than reducing the prior year divisor by 1.0 each year, and sole beneficiaries do not have to start inherited IRA RMDs until the year deceased spouse would have reached 72. These latter two rules reduce rapid reduction of the inherited IRA via beneficiary RMDs.

However, the spousal beneficiary can also choose to do the spousal rollover of any portion of the inherited IRA, and do so several times. For example, roll over 30% to start with and when they get closer to 59.5 roll over another 30% or any other amount once they are sure that the penalty free inherited IRA amount remaining will be enough. For an inherited Roth IRA (the OP question), since regular contributions and aged conversions come out tax and penalty free anyway, more could be rolled over, and the more rolled over to an owned Roth, the less is left subject to beneficiary RMDs.

Since the beneficiary can make the partial spousal rollover decision, there is no need for the deceased spouse to create additional IRA accounts. The beneficiary starts with all them as inherited, and can make the spousal rollover decision themselves as needed.
I see that it's easier to manage than I thought. So, her best strategy if she inherits earlier than age 59.5 is to take my IRA as an Inherited IRA, but to take my Roth as her own to avoid possible RMDs on the Roth. If she needs to, she can take distributions up to her Roth basis, which is the total of both our conributions and conversions, without tax or penalty even prior age 59.5.
heikejohn1
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Re: Inherited Roth and the Five Year Rule

Post by heikejohn1 »

RMDs are required for inherited Roth IRAs, just not for owned Roth IRAs.
[/quote]

Where can I read up on this?
I had no idea!!

found this:
https://www.investopedia.com/roth-ira-r ... md-4770561

Options for Spouses
Do a spousal transfer (treat as your own). You transfer the assets into your own Roth IRA (an existing one or a new one). You're subject to the same distribution rules as the original account holder.2
Open an inherited IRA: life expectancy method. Here, you transfer the assets into an inherited IRA in your own name. You must take RMDs, stretched over your life expectancy. But you can postpone distributions until Dec. 31 of the year after they passed away. Distributions aren't taxed if the 5-year rule on inherited IRAs has been met. You could also base distributions on the age/life expectancy tables of the deceased—which would mainly be advantageous if your spouse was significantly younger than you were.3
Open an inherited IRA: 5-year method. You transfer the assets into an inherited IRA in your name. You can spread your distributions over time, but the account must be fully distributed by Dec. 31 of the fifth year after your spouse passed away. Distributions are not taxed if the 5-year rule has been met.3
Take a lump-sum distribution. When you take the lump-sum option, the Roth IRA assets are distributed to you all at once. If the account was less than five years old when your spouse passed away, the earnings will be taxable.


Options for Other Beneficiaries
A non-spouse who inherits a Roth IRA—the account holder's child, another relative, or even a friend—once had similar options to the above (except for the treat-as-your-own spousal transfer). But the SECURE Act, passed in December 2019, changed all that. No longer can non-spousal beneficiaries base the RMDs on their own life expectancies, or even the former owner's life expectancy. The new rules will require a full payout from the inherited IRA within 10 years of the death of the original account holder.
DIYtrixie
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Re: Inherited Roth and the Five Year Rule

Post by DIYtrixie »

Assuming the surviving spouse (and later, a subsequent beneficiary) will not need to spend from the Roth IRA soon (if ever), are there scenarios where the best course of action would NOT be:

1. Inheriting spouse treats the Roth IRA as their own (continue tax-free growth for their lifetime).
2. When this Roth IRA is subsequently inherited by a child (or other beneficiary), distribute the whole thing immediately to taxable and invest in a MF/ETF that does not distribute much/any gains (VTSAX, etc.).

This would minimize the inherited tax cost for both beneficiaries, without adversely affecting growth, correct? Of course there will be taxes due for the subsequent non-spouse beneficiary if the Roth IRA is eventually spent out, for example as a final asset class, but if total assets are smaller then, the tax rate should be lower.

Am I thinking about this correctly?
MrJedi
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Re: Inherited Roth and the Five Year Rule

Post by MrJedi »

DIYtrixie wrote: Mon Oct 25, 2021 6:23 am Assuming the surviving spouse (and later, a subsequent beneficiary) will not need to spend from the Roth IRA soon (if ever), are there scenarios where the best course of action would NOT be:

1. Inheriting spouse treats the Roth IRA as their own (continue tax-free growth for their lifetime).
2. When this Roth IRA is subsequently inherited by a child (or other beneficiary), distribute the whole thing immediately to taxable and invest in a MF/ETF that does not distribute much/any gains (VTSAX, etc.).

This would minimize the inherited tax cost for both beneficiaries, without adversely affecting growth, correct? Of course there will be taxes due for the subsequent non-spouse beneficiary if the Roth IRA is eventually spent out, for example as a final asset class, but if total assets are smaller then, the tax rate should be lower.

Am I thinking about this correctly?
The child has some options, but the best option is likely not to immediately distribute it. At a minimum you can choose the 10 year option where you don't touch it (no RMD) and let it stay tax free for 10 tax years and then distribute it all at the end into taxable. There are some other potential exceptions that can stretch longer than 10 years but involve annual RMDs.
Alan S.
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Re: Inherited Roth and the Five Year Rule

Post by Alan S. »

The child's age when inheriting should be considered. Assume we are referring to a child of the deceased Roth owner.

If very young, electing the 10 year rule (opting out of EDB status) will crimp the period of potentially tax free Roth gains. For example, a child at age 5 would have to take a full distribution at 15. However, if that same child is treated as an EDB, the 10 year rule does not kick in until 18 in most states, and up to age 26 if the child remains enrolled in "a specified course of education". Unfortunately, the IRS has still not defined "a specified course of education", and they need to get to this. But the point is that the inherited Roth could survive up to age 36 for some children.

It should be noted that taking the small inherited Roth RMDs of a minor EDB would normally be non taxable as a return of basis and therefore would not trigger the kiddie tax. After 5 years from the year of the owner's first contribution, the inherited Roth will be qualified and entirely tax free. Therefore, no kiddie tax would occur unless the owner had already taken out their regular and conversion contributions and left only earnings to the minor child, and this is very unlikely.
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Lee_WSP
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Re: Inherited Roth and the Five Year Rule

Post by Lee_WSP »

DIYtrixie wrote: Mon Oct 25, 2021 6:23 am Assuming the surviving spouse (and later, a subsequent beneficiary) will not need to spend from the Roth IRA soon (if ever), are there scenarios where the best course of action would NOT be:

1. Inheriting spouse treats the Roth IRA as their own (continue tax-free growth for their lifetime).
2. When this Roth IRA is subsequently inherited by a child (or other beneficiary), distribute the whole thing immediately to taxable and invest in a MF/ETF that does not distribute much/any gains (VTSAX, etc.).

This would minimize the inherited tax cost for both beneficiaries, without adversely affecting growth, correct? Of course there will be taxes due for the subsequent non-spouse beneficiary if the Roth IRA is eventually spent out, for example as a final asset class, but if total assets are smaller then, the tax rate should be lower.

Am I thinking about this correctly?
If you are describing a scenario where the child remains a minor upon the passing of the second spouse...

The survivor should transform the accounts into their own accounts upon or just before the date when the decedent would have been required to take distributions. See this for clarification of what I mean: https://www.kitces.com/blog/successor-b ... eneficary/

As far as minor children are concerned, irrespective of the compressed tax brackets, I strongly recommend setting up accumulation trusts for the children rather than relying upon a UTMA or conservatorship transfer. This will not matter for a Roth account as the taxes are pre-paid, but will potentially incur higher taxes on a TDA. Nevertheless, I believe the asset and spendthrift protections are worth the trade off. The alternative is to not leave TDA's to minors, but this may not be feasible according to the overall plan.

IANYL, see your own trusts & estates attorney for more information on these strategies.
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