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By Jeffrey Levine, Director of Retirement Education
Roth IRAs offer many benefits. Without a doubt, the ability to accumulate funds for retirement on a tax-free basis is clearly their biggest perk, but another huge advantage, relative to other retirement accounts, is that they do not have any required minimum distributions (RMDs) during your lifetime.
That’s true of your Roth IRAs during your lifetime, but it doesn’t hold true for all Roth money all of the time. Failure to understand this simple fact can lead to big penalties. A missed RMD is subject to a 50% penalty on a shortfall. Can you imagine having a 50% penalty on a distribution that probably would have been tax free? If the thought makes you sick to your stomach, make sure that you know about the RMDs the following Roth accounts do have. Designated Roth Accounts (DRAs) Designated Roth accounts, or DRAs for short, are Roth accounts held inside an employer-sponsored retirement plan, like a Roth 401(k) or Roth 403(b). It sounds like a bunch of alphabet soup, but DRAs are subject to RMDs. Although Roth IRAs have no RMDs during your lifetime, designated Roth accounts are subject to RMDs. They follow the plan rules, so in general, Roth 401(k) and similar DRA accounts will be subject to RMDs once you turn age 70 ½. However, if a you are still working, are not more than a 5% owner of the company you work for and your plan allows you to delay RMDs, the still-working exception would apply to the designated Roth account as well as the traditional side of your plan.
Also, if you want to avoid RMDs with your DRA assets, you can roll them over to a Roth IRA in the year before you turn age 70 ½ or earlier. If you do that, the entire amount can generally be rolled over to your Roth IRA and RMDs can be avoided for the remainder of your lifetime. If, however, you wait until the year you are age 70 ½ or later to execute this rollover, you must first take an RMD from your plan, before you are eligible to roll any amounts in excess of the RMD over to your Roth IRA. Inherited Roth IRAs Roth IRAs have no RMDs during your lifetime, but if there is any money left in your Roth IRA when you die, your heirs – other than (possibly) your spouse – will have to take RMDs from the inherited Roth IRA. Post-death RMDs for inherited Roth IRAs are calculated similarly to the post-death RMDs for inherited traditional IRAs; the big difference is that they are generally tax free.
If you’ve had any Roth IRA for more than 5 years at the time of your death, everything that your heirs take from their inherited Roth IRA will be 100% income tax and penalty free. Period. End of story. If you haven’t had any Roth IRA for more than 5 years at the time of your death, any contributions and conversions that remain in your account can still be distributed tax and penalty free to your heirs. However, earnings, which are the last funds paid out under the ordering rules for Roth IRA distributions, would be taxable – but not subject to penalty – if withdrawn within 5 years of your first Roth IRA.