Taxation of inherited Roth IRA distributions
hi,
i’m doing some research on the benefits of converting to a roth IRA next year and i found conflicting information regarding the taxation of distributions from inherited roth IRAs.
the majority of articles i read say that all distributions from inherited roth IRAs are tax-free to beneficiaries, but i found an article in the 9/2008 journal of financial planning (“Creating a Comfortable Homestretch”) that claims roth IRA distributions are only tax-free up to the date of death value of the original owner. any post-death appreciation of the roth is subject to ordinary income tax when distributed. in other words, if i inherit a $1 million roth IRA from my father when he passes away and take required distributions over my life expectancy, distributions are tax-free up to $1 million, but distributions beyond that point are taxed as income (same as a traditional IRA). is this correct or are all roth IRA distributions tax-free regardless of the date of death value? also, does it make a difference if the roth IRA was established by contributions vs. a conversion?
thanks for any responses.
chad
Permalink Submitted by mk foss on Wed, 2009-08-12 01:19
The date of death value is not a factor as you describe it in your example. If an individual were to create a Roth IRA with a conversion of $400,000 and die one year later – earnings could still be taxable if withdrawn before the five year period. So if he converts in year one, dies in year two, beneficiary must take first RMD in year three, second RMD in year four and third RMD in year five. If there are earnings included with those RMDs, they would be taxable.
However, withdrawals from Roth IRAs come first from contributions (none in my example), then from conversion amounts and finally from earnings. The beneficiary would have to take out more than the $400,000 initial amount in year three, four or five in order to have any taxable earnings. I don’t think that’s likely unless the beneficiary withdraws the entire balance before the end of the five-year period that began with the original owner’s conversion.
Permalink Submitted by Alan Spross on Wed, 2009-08-12 01:45
Chad,
It’s amazing that an article like that would make the Journal of Financial Planning. I thought such articles were vetted and proof read for errors prior to publication, but apparently that one escaped any quality screens. That is unless you misintrepreted what it said……….further, there have been no changes to taxation of inherited Roths since they debuted in 1998.
Permalink Submitted by Bruce Steiner on Wed, 2009-08-12 03:50
I found it hard to believe that Chad would be correct that the Journal of Financial Planning would publish an article with such a clear error, so I went back to the September 2008 issue to check. (If you’re a member of the Financial Planning Association, as I am, you can view articles from the archives on their website.) Lo and behold, not only did the article contain this error, but this error appeared twice within the article.
The statements in question were not footnoted with citations to any authority. Indeed there were no footnotes nor any citations to any authority, either to primary sources or to articles by others, in the entire article.
Permalink Submitted by chad bollenbach on Wed, 2009-08-12 14:50
thanks to everyone for their helpful responses!
chad
Permalink Submitted by Alan Spross on Wed, 2009-08-12 21:12
Thanks to Bruce for verifying that Chad was in fact correct about this article. I guess it shows that errors can potentially show up where least expected.