The Roth IRA Tax Rules for Heirs

Not all inherited Roth IRA distributions are tax-free.

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The after-tax nature of Roth IRA savings allow people to use them to leave money to their heirs without burdening the heirs with taxes on the distributions. However, failing to take the required distributions from an inherited Roth IRA could turn a potentially tax-free inheritance into a windfall for the Internal Revenue Service.

Surviving Spouse Benefits

Like other IRAs, if you are the decedent's surviving spouse, you have a special option to treat the inherited Roth IRA as if it were your own account. If you make this election, you don't have to worry about taking any required distributions during your lifetime because Roth IRAs do not require minimum distributions for the account owner. However, you must personally meet the criteria to take a qualified distribution from the Roth IRA because once you elect to treat the IRA as your own, you're no longer a beneficiary. To take a qualified Roth IRA distribution, the account must have been open for at least five years and you must be 59 1/2, or you must be using up to $10,000 for a first home or permanently disabled.

Non-Spousal Heirs

As a non-spousal heir of a Roth IRA, you must take required minimum distributions from the account. The default rule is that you must empty the inherited Roth IRA before the close of the fifth calendar year following the decedent's death. For example, if the decedent dies in July 2013, you would need to empty the account by December 31, 2018. However, you can also elect to take minimum annual distributions based on your life expectancy. These usually allow you to stretch the distributions over a longer period of time.

Taxes on Distributions

Qualified distributions from an inherited Roth IRA come out completely tax-free. To take a qualified Roth IRA, distribution, the decedent must have had the Roth IRA for at least five years. The second portion of the criteria is satisfied automatically because you receive the distributions as an account beneficiary. If you take a non-qualified distribution, you can take out the contributions tax-free, but when you remove the earnings, you'll have to pay income taxes.

Penalties for Not Distributing

If you fail to take required distributions, the IRS imposes a gargantuan 50 percent penalty on the amount you didn't take out, even if the distribution would have been tax-free. For example, assume that you were supposed to withdraw $12,000 from the IRA that you inherited from your father. If you fail to take that distribution, you owe the IRS $6,000 in penalties when you file your income taxes.