Many of the trickiest situations encountered by tax professionals are inherited IRAs and an Enrolled Agent is often the recipient of questions from IRA beneficiaries. Taxpayers who inherit IRAs are confronted with options that cause different tax consequences. The timing for taking action on inherited Roth IRAs is crucial. Individuals who obtain early advice from Enrolled Agent tax experts are able to avoid tax liability by meeting mandatory distribution requirements.
Roth IRAs have become increasingly common since the lifting of restrictions on conversions from traditional IRAs. This has permitted high-income individuals to obtain Roth accounts by converting after-tax contributions in traditional IRAs without any tax impact. Many are even transferring pretax balances from traditional IRAs to Roth IRAs and paying the associated tax. As a result, Enrolled Agent preparation for addressing cases where people inherit Roth IRAs has a rising relevance.
Holders of Roth IRAs are not required to take any minimum distributions. However, the situation changes when the account owner dies. A non-spouse beneficiary to a Roth IRA must take annual distributions based upon life expectancy or liquidate the entire account within five years. No tax is owed under either option. This is a crucial element uncovered during an Enrolled Agent course. The beneficiary can stretch the continuation of tax-free earnings in a Roth IRA over his life expectancy. However, if he fails to take the annual distributions, liquidation of the whole account must occur within five years.
The availability of ongoing tax-free growth is a powerful tool. This is especially true when beneficiaries are young children. Tax experts with EA certification can help people with this circumstance understand the path to substantial wealth accumulation. The minor child will have low mandatory annual distributions for the inherited Roth IRA. This leaves many years for the account balance to grow. Best of all, the beneficiary will never owe any income tax by taking minimum withdrawals. Higher distributions are allowed if needed in future years during adulthood.
The child of a Roth IRA owner who is the primary beneficiary may want to disclaim the account so that it goes to the owner’s grandchild named as a contingent beneficiary. Tax professionals who remember this rule from their Enrolled Agent training can present valuable recommendations in applicable instances. Disclaimers are required no later than nine months after the Roth IRA owner’s date of death. Another vital date is September 30 of the year following the owner’s death. This if the last day to finalize the designated beneficiary.
Ideally, an inherited Roth IRA with multiple beneficiaries should be split into separate beneficiary Roth IRAs. If this does not occur, the amount of required minimum distribution is based upon the life expectancy of the beneficiary with the shortest life expectancy. That is, the oldest individual beneficiary. If distributions do not begin by the end of the calendar year following the account owner’s death, the five-year rule applies. Failure to comply with either the life-expectancy method or the five-year rule triggers a nasty 50 percent penalty tax on amounts that should have been distributed.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.