We are often asked about Roth IRAs, taxes, and inheritance. We want to share an article from a mentor and coach*, Ed Slott. In this article, he’s answering a question specifically about leaving a Roth IRA from a grandparent to a grandchild. How long will they have to take the money out? And will the funds be taxable?
Watch this video for a quick summary:
Many people save money or convert assets into a Roth IRA over time. Upon your death, you’re able to stretch that money out to a non-spouse beneficiary for up to 10 years from the date of death. Because taxes were already paid on the contributions or the conversions, the Roth IRA is generally going to be tax-free to your heirs.
There is one exception. There’s a five-year holding rule in a Roth IRA, from the date the account was originally set up. So, if you established a Roth IRA, for example, at age 78, and you died at age 80, your beneficiary would need to hold the earnings in that Roth IRA account for at least three more years, to satisfy the five-year rule, before the earnings would be tax-free upon distribution.
Keep in mind that in the ordering rules of how money comes out of an IRA, earnings come out last. So hopefully, that beneficiary would be taking the money out over time. Then the earnings would have come out after the fifth year anyway. So, it includes the number of years you’ve had the IRA plus the number of years that the beneficiary needs to hold the IRA. You need a total of five years before all distributions of principal and interest are tax-free. That’s a unique part of Roth IRA taxation. What this really drives the point home about is that you should consider getting a Roth IRA established as soon as possible, and starting the five-year rule as soon as you can.
The five years starts from the date of the very first contribution to the account, even if you only put in $100 and you later fund it with much more. In addition to the Ed Slott article, reference our 2021 key data card, which will show you what the Roth contribution limits are, and also the eligibility requirements based on your income. For single filers, eligibility phases out after $125,000 of earned income. And for joint filers, it begins to phase out at $198,000. Check out the key data card and the article from Ed Slott.
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*Our founder, Calvin Goetz, is an Ed Slott Elite IRA Advisor.
This content is provided for informational purposes only. It is not intended to serve as the basis for an individual’s financial decisions. Investing involves risk, including the potential loss of principal. Strategy Financial Group does not provide specific tax advice. Please consult with your tax professional for guidance on your individual situation. Investment advice is offered through Strategy Financial Services, LLC, a Registered Investment Adviser. Insurance and annuity products are offered separately through Strategy Financial Insurance, LLC.