What Should I do with an Inherited Roth Ira?

If you inherit a Roth IRA, your options for using the account will depend on your relationship to the account owner. If you inherit a Roth IRA from your spouse, you will have more flexibility than if you inherit an account from a parent, grandparent or another relative or close friend. To minimize tax obligations, talk with an investment advisor about how to make the most of your inherited funds, especially before converting Roth account online.

Because the contributions to a Roth IRA come from post tax income, you will not be subject to income tax when you inherit a Roth IRA. However, you may be charged an estate tax if the total amount of money you inherit exceeds a maximum threshold. The money from an inherited Roth IRA can be withdrawn without the usual 10 percent tax penalty, but the original owner must have held the account for five years for this rule to apply. If the Roth IRA is less than 5 years old, it may be best to let the funds continue to grow until the 5 year limit has passed.

Inheriting from a Spouse

After a spouse dies, the surviving spouse has the option to treat a Roth IRA as his or her own account and continue making contributions. If you want to keep adding to the value of a Roth IRA and earning tax free interest and dividends from this investment, you can either treat the account as your own or combine your deceased spouse's Roth IRA with another Roth IRA in your own name. [1]

Because a Roth IRA has no minimum distribution requirements, a spouse is not required to take distributions from the account. If you prefer, you can include the account in your own estate and leave the money to your children or grandchildren. If you haven't retired yet, you may decide to use the funds to maintain your standard of living after your spouse dies, to pay his or her final expenses or to buy a home.

Inheriting from a Non-Spouse

When you inherit a Roth IRA from someone who is not your spouse, your choices are more restricted. You cannot claim the account as your own or continue to contribute to a Roth IRA that you've inherited from a non-spouse. If you are not the original owner's spouse, you may only combine an inherited Roth IRA with another Roth IRA if you inherited both accounts from the same person.

As long as the account is at least 5 years old, you may take tax free distributions from an inherited Roth IRA, regardless of your age or the age of the original owner at the time of death. If the account is less than 5 years old, you must pay a tax penalty if you withdraw the contributions early. As a non-spouse, you are required to take distributions from an inherited Roth IRA rather than allowing the account to continue to grow. You must either have the funds distributed by the end of the 5-year period after the account owner dies, or have the funds distributed throughout your lifetime. [1]

Once you've collected your distributions, you may invest the funds in your own retirement account or use the money for your current needs. After you inherit a Roth IRA, talk with an investment advisor about how to utilize inherited Roth IRA funds to enhance your own financial well being. When you inherit a Roth IRA, you have the opportunity to benefit from the tax free status of these flexible retirement accounts. Choose an option that minimizes or eliminates your tax obligations on this account.

http://www.irs.gov/publications/p590/ch02.html#en_US_2011_publink1000231084 01/21/2012

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