Navigating Inherited Roth IRAs: A Tax-Savvy Guide
Inherited Roth IRAs are subject to the 10-year rule, but with a significant difference: beneficiaries aren't taxed on withdrawals and aren't required to take Required Minimum Distributions (RMDs) since the original owner wasn't mandated to take them either. This allows for a flexible approach to withdrawals. Beneficiaries can opt to withdraw funds at their discretion over the 10-year span. By strategically waiting until the 10th year to deplete the account, beneficiaries can maximize tax-free growth opportunities if the Roth IRA is strategically positioned.
During the planning phase, beneficiaries should consider the following:
- Accelerating distributions during low-tax years
- Roth Conversions: transitioning an inherited 401(k) to an inherited Roth IRA
- Aligning distributions with college financial aid applications or Medicare premiums
Initially, there was confusion about the new rules, leading many to believe that non-spouse heirs inheriting a traditional IRA only needed to deplete the account within 10 years to comply. This strategy appeared to offer the flexibility of minimizing withdrawals during high-income years and taking larger distributions during low-income years.
In February 2022, the IRS clarified the rules concerning inherited IRAs under the SECURE Act. According to the IRS interpretation, if a parent passed away on or after the date they were required to begin taking minimum distributions, the beneficiary must follow specific guidelines. This entails taking RMDs based on their own life expectancy during years one through nine, followed by depleting the entire balance in year 10.
Essentially, once the original account owner commences taking RMDs, beneficiaries cannot halt them. However, beneficiaries aren't obligated to withdraw the same amount that the parent would have been required to withdraw. This clarification underscores the structured approach beneficiaries must now adhere to under the updated rules.
The IRS addressed the confusion by waiving penalties for individuals who failed to take Required Minimum Distributions (RMDs) from inherited IRAs due in tax years 2020 to 2024. This relief aimed to allay concerns and offer some flexibility during the uncertain period surrounding the interpretation and implementation of the new rules.
On April 16, 2024, the IRS issued Notice 2023-35, extending the waiver of the excise tax applicable to certain 10-year beneficiaries to 2024. As a result, beneficiaries subject to the 10-year rule and required to take annual required minimum distributions receive a waiver of the 25% excise tax that could have applied to their 2024 RMDs. It's important to note that the excise tax is waived, not the RMDs. This distinction shapes your options and your RMD obligations.
The penalty for missing a distribution is 25% of the amount that should have been withdrawn. (The penalty decreases to 10% if the missed RMD is compensated within two years.) This excise tax 25% penalty was reduced from 50% if an account owner failed to withdraw the full RMD amount by the due date.
The primary lesson is that non-spousal beneficiaries need to stay informed. Tax laws are subject to change, so staying updated on any revisions is crucial for effective financial planning.
At Savvy, we assist clients with tax planning and strategy, assessing their current circumstances and planning to minimize taxes in the future as tax laws evolve.
‍
Meet
Alex Austin
Hello there 👋🏼 I’m Alex Austin a CERTIFIED FINANCIAL PLANNER™ at Savvy, specializing in financial planning. I like to consider myself to be the GPS in a client’s financial life so they can reach their financial and retirement destination with the most efficient and optimal route.Â
All advisory services are offered through Savvy Advisors Inc. (“Savvy Advisors” or “Savvy”), an investment advisor registered with the Securities and Exchange Commission (“SEC”). Material prepared herein has been created for informational purposes only and should not be considered investment advice or a recommendation. Information was obtained from sources believed to be reliable but was not verified for accuracy. It is important to note that federal tax laws under the Internal Revenue Code (IRC) of the United States are subject to change, therefore it is the responsibility of taxpayers to verify their taxation obligations.Â
Navigating Inherited Roth IRAs: A Tax-Savvy Guide
Inherited Roth IRAs are subject to the 10-year rule, but with a significant difference: beneficiaries aren't taxed on withdrawals and aren't required to take Required Minimum Distributions (RMDs) since the original owner wasn't mandated to take them either. This allows for a flexible approach to withdrawals. Beneficiaries can opt to withdraw funds at their discretion over the 10-year span. By strategically waiting until the 10th year to deplete the account, beneficiaries can maximize tax-free growth opportunities if the Roth IRA is strategically positioned.
During the planning phase, beneficiaries should consider the following:
- Accelerating distributions during low-tax years
- Roth Conversions: transitioning an inherited 401(k) to an inherited Roth IRA
- Aligning distributions with college financial aid applications or Medicare premiums
Initially, there was confusion about the new rules, leading many to believe that non-spouse heirs inheriting a traditional IRA only needed to deplete the account within 10 years to comply. This strategy appeared to offer the flexibility of minimizing withdrawals during high-income years and taking larger distributions during low-income years.
In February 2022, the IRS clarified the rules concerning inherited IRAs under the SECURE Act. According to the IRS interpretation, if a parent passed away on or after the date they were required to begin taking minimum distributions, the beneficiary must follow specific guidelines. This entails taking RMDs based on their own life expectancy during years one through nine, followed by depleting the entire balance in year 10.
Essentially, once the original account owner commences taking RMDs, beneficiaries cannot halt them. However, beneficiaries aren't obligated to withdraw the same amount that the parent would have been required to withdraw. This clarification underscores the structured approach beneficiaries must now adhere to under the updated rules.
The IRS addressed the confusion by waiving penalties for individuals who failed to take Required Minimum Distributions (RMDs) from inherited IRAs due in tax years 2020 to 2024. This relief aimed to allay concerns and offer some flexibility during the uncertain period surrounding the interpretation and implementation of the new rules.
On April 16, 2024, the IRS issued Notice 2023-35, extending the waiver of the excise tax applicable to certain 10-year beneficiaries to 2024. As a result, beneficiaries subject to the 10-year rule and required to take annual required minimum distributions receive a waiver of the 25% excise tax that could have applied to their 2024 RMDs. It's important to note that the excise tax is waived, not the RMDs. This distinction shapes your options and your RMD obligations.
The penalty for missing a distribution is 25% of the amount that should have been withdrawn. (The penalty decreases to 10% if the missed RMD is compensated within two years.) This excise tax 25% penalty was reduced from 50% if an account owner failed to withdraw the full RMD amount by the due date.
The primary lesson is that non-spousal beneficiaries need to stay informed. Tax laws are subject to change, so staying updated on any revisions is crucial for effective financial planning.
At Savvy, we assist clients with tax planning and strategy, assessing their current circumstances and planning to minimize taxes in the future as tax laws evolve.
‍
Meet
Alex Austin
Hello there 👋🏼 I’m Alex Austin a CERTIFIED FINANCIAL PLANNER™ at Savvy, specializing in financial planning. I like to consider myself to be the GPS in a client’s financial life so they can reach their financial and retirement destination with the most efficient and optimal route.Â
All advisory services are offered through Savvy Advisors Inc. (“Savvy Advisors” or “Savvy”), an investment advisor registered with the Securities and Exchange Commission (“SEC”). Material prepared herein has been created for informational purposes only and should not be considered investment advice or a recommendation. Information was obtained from sources believed to be reliable but was not verified for accuracy. It is important to note that federal tax laws under the Internal Revenue Code (IRC) of the United States are subject to change, therefore it is the responsibility of taxpayers to verify their taxation obligations.Â
