Roth IRA

A Roth Individual Retirement Account (Roth IRA) is a tax-advantaged savings account that is established and funded by an individual to accumulate retirement savings. A Roth IRA is generally funded through after-tax annual contributions and rollovers from other eligible retirement plans, such as 401(k) plans.

A Roth IRA is a type of IRA that is easy to establish and provides the account owner with flexibility and control over their contributions, investments, and distributions. Investment earnings generally grow tax-deferred and may be distributed tax-free, which makes the Roth IRA a great option for tax savings and tax-free growth for those who meet the modified adjusted gross income (MAGI) requirements.

Eligibility to establish and contribute to a Roth IRA is open to anyone who has earned income under certain gross income limits. Earned income is the compensation you receive from working that includes wages, commissions, and self-employment income. You can have a Roth IRA even if you have a retirement plan with your current employer.

To establish a Roth IRA, you must sign a Roth IRA plan agreement with an IRA custodian. Banks, life insurance companies, mutual fund companies, brokerage firms and other financial institutions can act as an IRA custodian. The IRA custodian will provide you with a copy of the plan agreement and a disclosure statement that explains the Roth IRA rules.

You can establish a Roth IRA at any time. If you want to make an annual contribution for this year, you have until your tax return deadline, generally April 15 of next year, to establish the IRA and make the contribution.

The Internal Revenue Service (IRS) determines annual IRA contribution limits that adjust for annual inflation each tax year. You can make an annual contribution of up to $6,500 (for 2023) or 100% of compensation, whichever is less. If you are age 50 or older, you may make an additional catch-up contribution of $1,000. The annual contribution limits apply to all of your traditional and Roth IRAs in aggregate.

You are not required to make a Roth IRA contribution each year and you can vary the amount you choose to contribute each year.

Contributions to a Roth IRA are not tax-deductible. They are referred to as “after-tax” contributions that are made with after-tax dollars (the money left after your income tax has been paid). 

You can transfer or roll over Roth IRA assets into another Roth IRA. If you are eligible to take a distribution from your employer’s retirement plan, you can roll over your designated Roth contributions from your employer’s plan to your Roth IRA. Additionally, you can roll over pre-tax assets in your employer’s plan to a Roth IRA. The pre-tax amounts of the rollover funds must be included in your taxable income for the year of distribution from your employer’s plan. Traditional, SEP, and SIMPLE IRA assets may also be converted to a Roth IRA in a taxable transaction called a conversion.

You can take distributions from your Roth IRA in the form of withdrawals at any time. The portion of the distribution that consists of contributions and rollover assets will be tax-free because you have already paid tax on those assets. If the distribution is made after you have had a Roth IRA for at least five years, and you have attained age 59½, died or become disabled, the earnings will also be distributed tax-free and penalty-free. If these conditions are not satisfied, any earnings included in the Roth IRA withdrawal will be taxable income in the year of the distribution. Earnings that are taxable may be subject to a 10% early withdrawal penalty if you are not yet age 59½. Roth IRAs do not require withdrawals until after the death of the owner; however, beneficiaries of a Roth IRA are subject to the required minimum distribution (RMD) rules.

1. Understand your options – When you inherit a Roth IRA account following the Roth IRA owner’s death, federal tax laws require that you distribute the account balance within a certain time frame. The laws provide a few payment options. The financial institution where the Roth IRA is located (Roth IRA custodian) may have more restrictive policies than what is permitted under federal law, so you will want to contact the Roth IRA custodian to confirm your options. Depending on the dollar amount and the types of investments in the Roth IRA, you may also want to seek the advice of a financial advisor or tax professional before you make any decisions.

2. Provide a death certificate – Before you can withdraw money from the Roth IRA, the new account holders or the personal representative of the Roth IRA owner’s estate will need to provide a certified death certificate to the Roth IRA custodian.
 
3. Meet the deadline – Under the tax laws, you have until December 31 of the year following the year the Roth IRA owner died to take your first payment or provide instructions regarding how you want to take payments from the Roth IRA. The Roth IRA custodian may impose other deadlines.

You can always take payments more rapidly, but if you decide to leave the money in the inherited Roth IRA long-term, you must take out a minimum amount each year. Spreading payments over multiple years allows the assets to grow tax-free for as long as possible. How long you have to deplete the account depends on whether you are a spouse or a non-spouse beneficiary.

For spouse beneficiaries:

• 5-year rule
• Life Expectancy payments
• Treat Roth IRA as own 
For non-spouse beneficiaries:

• 5-year rule
• Life Expectancy payments

Under the five-year payment option, you can withdraw any amount each year, or none, but you must deplete the IRA by the end of the year containing the fifth anniversary of the Roth IRA owner’s death.
 
Although the rules for traditional IRAs do not permit the five-year payment option if the traditional IRA owner dies after his or her required beginning date, the five-year payment option is always available for Roth IRA beneficiaries, regardless of the Roth IRA owner’s age at death.
 
Example: Assume your Aunt Sally died on July 1, 2017, at age 68, and named you as the beneficiary of her Roth IRA. If you elect the five-year rule payment option, you may take distributions at any point during the five years following Sally’s death as long as you deplete the IRA by December 31, 2022 – the year containing the fifth anniversary of Sally’s death.

Under the life expectancy payment option, you must withdraw a minimum amount each year. (You can always withdraw more if you want.) These payments must begin by December 31 of the year following the year the Roth IRA owner died. A payment is due by December 31 every year until the Roth IRA is depleted.
 
The minimum amount you must distribute is calculated by dividing the prior-year December 31 Roth IRA balance by your life expectancy, which is found in the IRS’s Single Life Expectancy Table.
 
Example: Assume your Aunt Sally died on July 1, 2017, at age 68, and named you as the beneficiary of her Roth IRA. Her Roth IRA balance as of December 31, 2017 is $100,000. You would use the life expectancy for your age in 2018 (the year after death) to calculate the first payment. If you were age 45 in 2018, the life expectancy would be 38.8. The payment would be $2,577.32 ($100,000/38.8). For the next year’s calculation, you would subtract one from the previous year’s life expectancy (38.8-1 = 37.8) and so on for each subsequent year’s calculation. 
 
If you are a spouse beneficiary, you have two extra options:
• You could wait until your spouse would have turned 70½ before you start taking annual payments.
• For each year’s payment, you can use your actual age to determine the life expectancy factor rather than reducing the first year’s factor by one. This method results in a slightly smaller required payment than a non-spouse beneficiary calculation.

If there are multiple beneficiaries named for the Roth IRA, each beneficiary may calculate life expectancy payments based on their own life expectancy if each beneficiary’s share is separately accounted for by the Roth IRA custodian. Separate accounting must be set up by December 31 of the year following the year the Roth IRA owner died. If this deadline is not met, the minimum annual payments may have to be calculated based on the oldest beneficiary’s life expectancy.
 
Depending on the Roth IRA custodian’s policies, it may set up a separate account for each beneficiary on its operating system or may request that each beneficiary sign IRA documents to establish an inherited Roth IRA.
 
Each beneficiary must withdraw his or her share of the required amount each year.

You are responsible for ensuring that you take at least the minimum required amount from your inherited Roth IRA each year. If you choose to take life expectancy payments, you will need to calculate your minimum amount. The Single Life Expectancy Table and instructions for calculating payments can be found in IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs):
 
https://www.irs.gov/publications/p590b#en_US_2017_publink1000230812

The Roth IRA custodian may allow you to take over the existing Roth IRA. Some Roth IRA custodians will require you to sign documents to establish a Roth IRA in your name. You may also transfer the assets to your own Roth IRA if you already have one.
 
If you choose to treat your spouse’s Roth IRA as your own Roth IRA, you can make contributions and take distributions at will. In this case, your age and your Roth IRA five-year clock will determine whether a distribution qualifies as a tax-free “qualified distribution.”
 
To be qualified, the distribution must occur after you have had a Roth IRA for at least five years, and you have attained age 59½, died or become disabled. If these conditions are not satisfied, any earnings included in a distribution will be taxable income in the year of the distribution. Earnings that are taxable may be subject to a 10% early distribution penalty if you are not yet age 59½.

As long as the Roth IRA owner had a Roth IRA (does not have to be the Roth IRA that you inherited) for at least five years before he or she died, all of your Roth IRA beneficiary payments will be tax-free.
 
If the Roth IRA owner did not have a Roth IRA for at least five years before death, you will pay tax on the earnings portion of your Roth IRA beneficiary payments until the five-year requirement has been met.  The portion of the distribution that consists of contributions and rollover assets will always be tax-free. The ordering rules for Roth IRAs deem contributions to be the first money distributed from a Roth IRA. So, you can still withdraw tax-free money if you only withdraw the amount of contributions (and rollovers and conversions) that have been made and do not touch the investment earnings. Once the Roth IRA has been in existence for five years, all of your payments from the Roth IRA will be tax-free.
 
If you are a spouse beneficiary who treats the inherited Roth IRA assets as your own, you must meet the requirements for a qualified distribution (owned a Roth IRA for at least five years and are age 59½ or disabled) for the earnings to be withdrawn tax-free.

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