When inheriting an IRA, Roth IRA or other retirement account, it can be tempting to cash out. In many cases, taking advantage of the provisions in current law to stretch the account would lower the tax bill and the usefulness of the funds.
Q.: You stated in a prior question that if you inherited a Roth IRA, you would be subject to RMD. Id like to know how that works.
A.: Frank, yes inherited Roth IRAs are subject to Required Minimum Distributions (RMD). Many retirees dread RMD on their IRAs and other retirement accounts because they dont need the money and dont want to pay the taxes that result from a distribution.
Inherited Roth accounts are different. In most cases, distributions will be tax free. If you dont need the money, you take just the minimum amount leaving the rest to grow. This results in a larger pool of tax-free funds that can be used later than if you take the money out faster.
If you take the first RMD from the Inherited Roth IRA by Dec. 31 of the year after the year of the Roth IRA owners death, you can draw down the account over your life time. This is commonly referred to as a stretch Roth IRA because you are stretching distributions over many years. You always have the option to take more than the minimum and can empty the account at any time.
If you do not take the first RMD on time, you must distribute the entire account by the end of the fifth tax year after the year of the owners death. Once out of the Roth environment, those funds are subject to tax based on how they are invested.
The same basic rules and processes apply to inherited traditional IRAs. It can be even more important to get the first RMD out on time with traditional IRAs to establish stretch capability because forcing the account to be fully distrusted in five years or less can result in a lot of taxes
Here is how the RMD on an Inherited Roth IRA works. You die in 2017 (sorry about that) and named your son as the beneficiary of your Roth IRA. Say he will be 50 years old on Dec. 31, 2018. According to the IRS schedule (Appendix B, Table I) for inherited accounts, his factor is 34.2.
He should take the Dec. 31, 2017 account value and divide by 34.2. That is the RMD that must be removed by the end of 2018. It doesnt matter how many distributions he takes or when during 2018 he takes them, as long as the total of all the distributions in 2018 equal or exceed that RMD amount, he will be on a stretch program.
For the RMD retirees face on their traditional IRAs, they must refer to their IRS scale annually. He does not refer to the IRS scale in future years for inherited accounts. He simple reduces the dividing factor by one every year going forward.
So, for 2019, he would take the Dec. 31, 2018 balance and divide by 33.2. For 2020, he takes the Dec. 31, 2019 balance and divides by 32.2. For 2021, its the Dec. 31, 202 balance divided by 31.2, and so on until the account is empty.
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Dan Moisands comments are for informational purposes only and are not a substitute for personalized advice. Consult your advisor about what is best for you. Some questions are edited for brevity.