YOUR ROTH IRA CAN GROW, BUT NOT FOREVER
If you have a Roth IRA, you know the benefits of this account. You can take distributions from it over your lifetime without paying any tax on the interest accumulated as long the distributions are considered to be “qualified.” This means that you must have had your Roth IRA for at least five years and be at least age 59 ½ when you begin to take distributions. But you also are not required to take money from the account which means you do not have to start taking required minimum distributions when you turn age 70 ½. If you don’t need the money in retirement, you can let it continue to grow, leaving it for your named beneficiaries. Source: NLG
While you, as the IRA owner, are not forced to take money from your Roth IRA, your beneficiaries don’t have that same luxury. Even though no income tax would be due, upon your death your beneficiaries will be required to draw income out. While the IRS is agreeable with letting the money go undistributed while you are alive, they don’t want the money growing forever. Generally beneficiaries have two options: 1) take a lump sum or 2) begin receiving payments each year based on their single life expectancy so, essentially, taking minimum distributions over their life time. If your beneficiary elects to take the payments over life expectancy, the payments must begin by December 31st of the year following your death. If this does not happen, then your beneficiary will be required to withdraw all of the assets in the IRA by the end of the fifth year after your death.
There are some exceptions if the beneficiary is your spouse and is your sole designated beneficiary. If you were to die prior to age 70 ½, your spouse is allowed to delay taking a distribution until December 31st of the year you would have attained age 70 ½. Also, your spouse can move your Roth IRA into a Roth IRA of his or her own. But a non-spouse beneficiary cannot move your Roth IRA into a Roth IRA of their own. They can treat the account as an inherited IRA. If they do this, the assets can continue to grow untaxed, withdrawals are tax free and your beneficiary is allowed to name their own beneficiary. If your beneficiary dies prior to reaching their life expectancy, the balance of the payments will go to their named beneficiary.
Even though your beneficiary is required to take at least a minimum amount from the account each year, it is their money to use in any way that they wish. If they have a need for life insurance, they could use the distribution to pay the premiums on a life insurance policy. They can reinvest the money. It is theirs to do whatever they want. So even though your beneficiary has to take distributions, by creating the Roth IRA, you can create a tax free legacy to your beneficiaries.
Just as with qualified minimum distributions, your beneficiary will be incur a penalty for failure to take minimum distributions. If the minimum is not taken in a given year, a 50% excess penalty tax will be applied to the amount that should have been withdrawn but was not withdrawn.
These are the usual options but your Roth IRA plan document may specify how quickly the beneficiaries have to take distributions. If you are uncertain of the options, you should contact your IRA trustee/custodian or your financial advisor.
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