At some point, all individual retirement accounts (IRAs), both Roth and traditional, must have their balances distributed to their account owners. The key difference between the two types of IRAs is that you don't need to take any distributions from a Roth IRA during your lifetime.
- You must take required minimum distributions (RMDs) from a traditional IRA starting at age 72.
- Unlike traditional IRAs, there are no RMDs for Roth IRAs during the account owner’s lifetime.
- Your account's beneficiaries may need to take RMDs to avoid penalties.
RMD Rules for Roth IRAs
Required minimum distributions (RMDs) represent the minimum amount of money that you must take out of your retirement account each year. That amount is specified by the Internal Revenue Service (IRS) and, in the case of traditional IRAs, the amount of the withdrawal is taxed as income at your current tax rate. The IRS also imposes a 50% penalty on any missed RMDs.
You must begin taking RMDs from a traditional IRA by April 1 of the year after you turn 72 (the old threshold of 70½ still applies if you hit that age by Dec. 31, 2019). You must take them even if you don’t need the money for living expenses; the IRS is basically saying, "We want to collect some revenue on those funds!" The amount of your RMD is based on both your prior year’s account balance (as of Dec. 31) and an IRS table based on your age. Many other types of retirement accounts, including 401(k) plans, follow a similar set of rules. Almost always, you must pay income taxes on those withdrawals. Even if you don't, you no longer get tax-free growth on that money.
One of the great advantages of Roth IRAs is that they are not subject to the same RMD rules. If you have a Roth IRA, you don’t need to take RMDs during your lifetime. So if you don’t need the money, you can leave the funds untouched and let the account grow tax-free (for decades) for your heirs. Your beneficiaries—other than a surviving spouse—must take RMDs later, however.
What Are the RMDs for Roth Beneficiaries?
When you leave a Roth IRA to your beneficiaries, they—unlike you—do have to take RMDs from the account. They will also face a 50% penalty (or “excise tax”) if they don't take the distributions as required, so it pays to understand the rules—and make sure your beneficiaries do, as well.
The rules differ depending on whether the Roth is inherited by a spouse or by a different beneficiary.
Options for Spouses
- Do a spousal transfer (treat as your own). You transfer the assets into your own Roth IRA (an existing one or a new one). You’re subject to the same distribution rules as if you were the original account holder.
- Open an inherited IRA: life expectancy method. Here, you transfer the assets into an inherited IRA in your name. You must take RMDs, stretched over your life expectancy. But you can postpone distributions until Dec. 31 of the year after he or she passed away. Distributions aren’t taxed if the 5-year rule on inherited IRAs has been met. You could also base distributions on the age/life expectancy tables of the deceased—which would mainly be advantageous if your spouse was significantly younger than you.
- Open an inherited IRA: five-year method. You transfer the assets into an inherited IRA in your name. You can spread your distributions over time, but the account must be fully distributed by Dec. 31 of the fifth year after your spouse passed away. Distributions are not taxed if the five-year rule has been met.
- Take a lump-sum distribution. When you take the lump-sum option, the Roth IRA assets are distributed to you all at once. If the account was less than five years old when your spouse passed away, the earnings will be taxable.
Options for Other Beneficiaries
A non-spouse who inherits a Roth IRA—the account holder's child, another relative, or even a friend—once had similar options to the above (except for the treat-as-your-own spousal transfer). But the SECURE Act, passed in December 2019, changed all that. No longer can non-spousal beneficiaries base the RMDs on their own life expectancies, or even the former owner's life expectancy. The new rules will require a full payout from the inherited IRA within 10 years of the death of the original account holder.
The new SECURE Act rules will apply only to heirs of account holders who die starting Jan. 1, 2020; beneficiaries who already have inherited accounts are grandfathered.
Exempt from the new rules are non-spousal beneficiaries who fall into one these categories:
- disabled or chronically ill individuals
- individuals who are not more than 10 years younger than the IRA owner
- children of the IRA owner who have not reached the age of majority
Tax-Free Growth, Tax-Free Income: Pass It On
A Roth IRA can be an excellent wealth-transfer vehicle because you don’t have to draw down the account during your lifetime, and distributions are generally tax-free for your heirs.
One challenge with Roth IRAs is that your beneficiaries may not be aware of the RMD rules. So if you have a Roth IRA, do your beneficiaries a favor. Let them know the basics about distributions—or they'll get a costly lesson later when they're hit with a 50% penalty on the amounts they should have withdrawn. As long as everyone understands the rules, you and your heirs can enjoy years of tax-free growth and tax-free income from your Roth IRA.