What happens to my Roth account when I die?
Q.: Hi Dan,
I’m following up on your column on whether pension distributions can be put into a Roth after your RMD has been reached. I’ve been told that I have to put the additional distributions into a regular IRA if the funds come from a 401(k) to do this, then they can be transferred to a Roth and the funds that were added to the Roth have be in the account for five years to remain tax-free. Is it correct?
If that’s true, that’s what discouraged me. You never know when they will be called upon by their creator and I didn’t want to burden the recipient of the Roth with having to deal with them.
A.: Hi Kathrina,
Thanks for reading the columns and asking the question. Referring to “…I was told that I have to put the additional distributions into a regular IRA if the funds come from a 401(k) to do this, then they can be transferred to a Roth…”
I don’t think transferring funds to a traditional IRA is first required by the tax code or IRS procedures, but there is often a difference between what the IRS allows and the provisions included in plan documents. For example, the IRS allows “in-plan” conversions whereby 401(k) funds can be converted to a Roth 401(k) account inside the plan, but many plans do not allow such conversions. . If the plan doesn’t allow direct conversion to a Roth IRA, then yes, the funds would have to go into a traditional IRA first and then convert from there.
On “…that RMD funds that have been added to the Roth must be in the account for five years to remain tax-free.” This may be true but not always.
Since you are taking RMD, it is clear that you are over 59.5 years old. After age 59.5, when you convert, the converted money is taxed and available to you or your heirs tax-free from that time. Additionally, any other contributions you may have made to a Roth IRA and any other conversions you made to a Roth IRA before converting 401(k) funds are also tax-free. If you weren’t yet 59½, all of your contributions would be available tax-free, but a five-year rule specific to Roth IRA conversions would apply.
You may hear of another five-year rule. This applies to earnings rather than conversions prior to 59½. If more than five tax years have passed since you opened your first Roth IRA account, even if that Roth IRA no longer exists, the rule does not apply and the income from the account (amount greater than all contributions and conversions) are tax exempt. If you were under age 59.5, taxes and a 10% penalty apply to distributed income, unless you qualify for an exception.
In case of inheritance, if you die more than five years after opening your very first Roth IRA, all funds will be available tax-free to your heirs. If you die within five years of opening your very first Roth IRA (not five years from the date of your death), beneficiaries could immediately withdraw some or all of the contributions and tax-free conversions. If they then withdrew profits, these distributions could be taxed if withdrawn from the account during this five-year window. No 10% penalty would apply regardless of their age at the time of the distributions, as the death of the owner is one of the exceptions to the penalty. Once it was five years since you opened your first Roth IRA, everything could be withdrawn tax-free.
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Dan Moisand is a Financial Planner at Moisand Fitzgerald Tamayo and serves clients nationwide from offices in Orlando, Melbourne and Tampa Florida. His comments are for informational purposes only and cannot replace personalized advice. Consult your advisor to find out what is best for you. Some questions from readers are edited to facilitate the presentation of the topic.