Inheriting a Roth IRA

[Guest JOW EA]

Grandfather (age 70) lists Grandson (age 21) as the beneficiary of a $10,000 Roth IRA conversion. Upon Grandfather's death may the Grandson continue the Roth IRA and not take out any tax-free distributions? Could the Grandson leave the inherited Roth IRA in tact and transfer it at his death to his children or grandchildren and still be tax-free Roth IRA money when it is eventually taken out?

[BPickerCPA]

When a Roth IRA account holder dies, the beneficiary must either start to take distributions in the year after death, computed based upon bene life expectancy, or must take the entire account by 12/31 of the year of the fifth anniversary of death.

[Guest Mary Ann]

When a Roth IRA holder dies within the 5 year period after conversion, and the beneficiary is not the spouse, is it still possible to take distributions over the lifetime of the beneficiary? Or because the 5 year period has not been met does that classify any distribution as not being qualified and thus must be taken out before the end of five years? If this is so, then what about the following:

Example: IRA holder age 64 converts in 1998, dies in 1999. 5 year period for conversion purposes ends 1-1-2003 (?) - but the end of the fifth year after death is 12-31-2004. So if distributions could wait until 2004 would they then be considered qualified distributions since they are beyond the 5 year conversion?

[John Olsen]

The options to an IRA beneficiary, with respect to how much must be withdrawn and when, depend upon

(a) whether the IRA participant had reached her Required Beginning Date (4/1, following the year in which she turned age 70 1/2), and, if so,

(B) whether Life participant had been Recalculating her life expectancy annually, for Required Minimum Distribution purposes

If P died PRIOR to RBD, then the general rule is the Five Year Rule. That is, the entire account must be distributed by 12/31 of the year containing the 5th anniversary of the participant's death. The exception to the 5 year rule is the "SEPP" (Substantially Equivalent Periodic Payments) rule, which permits distribution over the beneficiary's life expectancy, provided distributions commence by 12/31 of the year following participant's death.

The foregoing assumes that the beneficiary qualifies as a "DESIGNATED BENEFICIARY". If not, the ENTIRE account must be distributed by 12/31 of the year following death.

Surviving spouses have additional options.

If the participant lived beyond her RBD, the Rule is "at least as rapidly as" was the account was being distributed. That does NOT mean quite what it says. For example, if P died, having timely designated P's child as beneficiary, and P had, during lifetime, been taking Required Minimum Distributions based on P's life expectancy only (which happens a lot, chiefly by reason of ignorance), that does NOT mean that, at P's death, C is stuck with the same payout. C is stuck with the payout P COULD HAVE used, legally, which was -

the remainder of the JOINT life expectancy of P and C (NOW no longer constrained by the MDIB rule), assuming P did not elect Annual Recalculation.

If P were using Annual Recalculation, C can use C's life expectancy as of P's first distribution year, reduced by the number of years since death.

This stuff gets VERY complicated. I HIGHLY recommend a couple of books for those involved in planning such things.

Seymore Goldberg's "How To Pay Less On Your Retirement Savings" (a Lasser paperback) is an EXCELLENT general treatment, written for the layperson.

Sy also has a couple of books written for professional advisors.

The "Bible" of Qualified Plan Distribution books, in my opinion, is Natalie Choate's "Life and Death Planning For Retirement Benefits". It's paperback, and SEVENTY NINE BUCKS!

And it's probably the best $79 I ever spent. Just wish I'd bought it sooner.

Goldberg's Lasser book is available at most bookstores. Choate's is available through her web site: www.ataxplan.com

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John L. Olsen, CLU, ChFC

Olsen Financial Group

Estate Planning, Investments, & Insurance Services

St. Louis, MO

[John Olsen]

Kathy,

A distribution by reason of the death of the participant is, by definition, a "qualified distribution".

[Guest DAVETAX]

MARY ANN: 1)A beneficiary can take distributions out over their life expectency only under the term certain method. 2)Distributions within the five year conversion period are not qualified distributions, but they should be tax free because of the ordering rules for withdrawals. 3) Distributions in 2004 in your example would be qualified distributions. 4)I refer you to IRS publication 590 on IRAs, chapter 2, which you can download at the irs web site. 5)I agree with John Olson that Natalie Choate's book "LIFE AND DEATH PLANNING FOR RETIREMENT BENEFITS" is a must addition to your library.

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DAVID SNYDER, CPA

[This message has been edited by DAVETAX (edited 03-27-99).]

[This message has been edited by DAVETAX (edited 03-27-99).]

[Guest Mary Ann]

Thank you all for your response. But, bottom line, I am interested in knowing about the Roth IRA rules. I am thinking they differ from the traditional IRA rules. So, the real issue I have a problem with is this:

Can a non-spouse beneficiary of a Roth IRA take distributions over his lifetime if the conversion happened less than 5 years before death?

I have been reading that this is not an option in this situation.. That the only option is that distributions must be made by the end of the 5th year following death. If death had occurred after the 5 year conversion period then the option to take distributions over the life of the beneficiary would be available.

Thank you for referring me to Natalie Choate's book. Does she cover Roth IRA's?

[John Olsen]

Dave,

Thanks for the correction. I misspoke in saying that distributions on death are, by definition, qualified distributions. They are not, UNLESS they're made after the five-year period beginning with the first IRA contribution. When CONVERTED assets are involved, the CONVERTED assets are not subject to tax, BUT THE EARNINGS ARE.

Thanks for keeping me "honest", Dave.

I gotta go back and re-read Natalie's supplement. Again.

John Olsen

[John Olsen]

Dave,

You say that the beneficiary in this case can take distributions over life expectancy, "but only under the term certain method". What is your source for that? Why would the other two methods for S.E.P.P. not be available?

John Olsen

[Guest DAVETAX]

JOHN, A ROTH IRA owner never has a required beginning date, thus no required minimum distributions. Therefore, a beneficiary can take distributions over his life expectency only under the term certain method. See the article by Gregory Kolojeski "REQUIRED MINIMUM DISTRIBUTIONS FOR TRADITIONAL AND ROTH IRAs" of 5/16/98 at the ROTH IRA web site. (rothira.com)

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DAVID SNYDER, CPA

[John Olsen]

Dave,

I was confusing [i get confused a LOT!] the Life Expectancy payout required under 401(a)(9)(B)(iii) (the Term Certain method you referred to, employing Table V life expectancy) and the three alternate ways of determining the amount of Substantially Equal Periodic Payments for 72(t)(3)(A).

Why I would do that, I don't know. I don't drink. But if I keep up messing around with 401(a)(9) much longer, I'm gonna go back on the sauce!

[John Olsen]

It is worth mentioning, I suppose, that the BEST way to deal with the difficulties of beneficiary designations and payout elections for IRAs and qualified plans IS TO DO PROPER PLANNING BEFORE THE PARTICIPANT HAS REACHED THE REQUIRED BEGINNING DATE.

On April 1st, following the participant's Age 70 1/2, several things get "carved in stone". Choices become irrevocable, INCLUDING "DEFAULT" CHOICES YOU MAY NOT KNOW ABOUT.

The choice of beneficiaries is CRUCIAL. So, in my opinion, is the election to use Annual Recalculation. That election is the DEFAULT for the participant on the IRS model 5305 form, and many financial institutions follow that model, EVEN TO THE POINT OF MAKING IT THE DEFAULT FOR A SPOUSAL BENEFICIARY.

What's the problem? The problem is, for VERY little benefit (the opportunity to reduce, SLIGHTLY, the amount one is REQUIRED to take, beginning at the Required Beginning Date), one runs the risk of having one's HEIRS forced to take distributions over a MUCH SMALLER period than would be available were the "term certain" election made (also known as "election NOT to re-calculate).

For anyone with IRA or qualified plan accounts, who is approaching age 70, I STRONGLY urge you to get competent counsel on your options, AND THE CONSEQUENCES OF EACH.

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John L Olsen, CLU, ChFC

Olsen Financial Group

St. Louis, MO

Where the IRA or qualified plan is payable to a Trust, I suggest SERIOUS attention! Not only must a Trust pass several tests to be considered a "designated beneficiary trust", but, it's a trust which will be funded by a "pecuniary bequest", the result could be that the ENTIRE IRA BALANCE PAID TO THAT TRUST WILL BE TAXABLE TO THE ESTATE IN THE YEAR OF FUNDING.

Natalie Choate spends considerable attention to this problem in Chapter 2 of her book. And a discussion on the specifics of this problem has been ongoing for weeks now, on the ABA-PTL Estate Planners List, on the Web.

[Guest Mary Ann]

Well, I think I have it - finally. But please tell me if this is right.

A non-spouse beneficiary of a Roth IRA which was converted fewer than 5 years before death of the owner has the following choices:

1) Can take the entire amount by the end of the 5th year after death - or

2) Can take payments over the beneficiary's life - but only the term certain method.

3) If option 2 is chosen, the distributions would come first from the converted amount so that no tax would be due since no earnings would be withdrawn until years down the road.

4) If option 1 is chosen and the 5th year after death is also beyond 5 years from conversion, then none of the earnings would be subject to tax.

I have read several articles by the people recommended by you contributors to this thread and found them very helpful.

So, is this finally right?

[Kathy]

No thanks to the rest of us, I think you've got it. The required beginning date does not apply to Roth IRAs. There are no required minimum distributions until the Roth IRA holder dies. At that time, the beneficiary can begin to withdraw money over his/her own life expectancy - go to the tables in Publication 590 from the IRS (call 1-800-TAX-FORM to order a copy), find the beneficiary's age on their birthday in the year after the year of death. Divide the prior year's ending balance (the year of the IRA holder's death) by the life expectancy factor. That is the amount that must be withdrawn that year. The next year, use last year's Life Expectancy factor minus 1 and do the same thing - divide the prior year's ending balance by the new LE factor. The other important data you will need is the account history. How many dollars were contributed to the Roth by the original Roth IRA holder? Those are used up first. Then, how many dollars were converted to the Roth by the original Roth IRA holder? Those are eaten up second. Neither of these two catagories will be taxable to the beneficiary. Chances are that you won't hit the earnings until after the five year period from the January 1 of the first year for which a Roth contribution or conversion was done if you use the Life expectancy method so you'll never owe taxes. Hope this helps!!!