If you’ve gone to all the trouble of setting up a Roth IRA you need to know what happens to that money after you are gone. Tom, a very nice man recently passed away. His wife Ann is the beneficiary of his Roth IRA. Will she have to take any distributions? Will they be taxable? What happens when Ann passes? Let’s answer these questions one by one. First we’ll tackle what happens to a Roth IRA after the owner dies.
Tim named Ann as beneficiary of the account as I said. Because she is the spouse, she can make Tim’s Roth her own. That means the money will be treated as if she always had it in her Roth. She can take the money out of the Roth of course and not pay any income tax. But if she wants to continue that sweet tax free growth she can. Ann won’t ever be forced to take a Required Minimum Distributions (RMD) as long as she’s alive. Once she rolls the Roth to her own account she can name any beneficiary she likes.
And by the way, it doesn’t matter what Tim’s trust says – the beneficiary designation determines where that money goes. That means Ann has to make sure she selects the right beneficiaries once she gets the money as well.
Let’s assume Ann passes before she remarries but names her only daughter Lucy as beneficiary before she dies. Lucy of course can take all the money out of the account when Ann dies without paying any tax on it. But she also has the right to set up an Inherited Roth IRA account.
If Lucy goes that way, most of the money will stay in the account and continue to grow tax-free. But Lucy will have to take RMDs each year (starting December 31 of the year after the owner dies). And if Lucy fails to comply with this rule, she’ll be forced to take all the money out of the account by the end of the fifth year after the year the owner died. That’s why it’s vital to keep track of RMDs – even for Roth accounts.
The RMD calculation for non-spousal Roth accounts is similar to the calculation used for regular inherited IRAs. It’s based on an IRS table that estimates your life expectancy on the year the owner died. I strongly suggest you read this post on RMD calculations for Inherited IRAs and understand how to make the calculation yourself. It’s really not that complicated but for some reason many CPAs and custodians get it wrong.
If Ann named more than one beneficiary, they should probably separate the accounts before the end of the year after the owner died. This way, they can use their own life expectancy. If they don’t split up the account, they will have to use the life expectancy of the oldest beneficiary and that means they will have to deplete the account faster.
Remember, the Roth gives you a huge bonus by allowing you to grow the money tax free. And keep in mind that somebody paid dearly for that privilege – they forked over a boat load of tax money in order to allow you to grow that pile-o-cash tax free. Make sure you get your money’s worth and stretch that Roth puppy as long as you can.
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