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Follow the rules to avoid a 50% penalty

Quick Summary

  • You have to take required minimum distributions (RMDs) from a traditional IRA starting at age 70 1/2.
  • There are no RMDs for Roth IRAs during the account owner’s lifetime.
  • Roth IRA beneficiaries may need to take RMDs to avoid penalties.

At some point, all IRAs must have their balances distributed. The rules that govern those distributions are known as required minimum distributions (RMDs). RMDs are the minimum amount of money you must withdraw from your account each year. That amount is specified by the Internal Revenue Service (IRS) and is taxed as income at your current tax rate.

It’s important to know the rules because there’s a 50% penalty on any missed RMDs. Here’s what you need to know.

Are Roth IRAs Subject to the Required Minimum Distribution Rules?

You have to start taking RMDs from a traditional IRA by April 1 of the year after you turn 70 ½. That’s true even if you don’t need the money. The amount of your RMD is based on your prior year’s account balance (as of Dec. 31) and an IRS table based on your age.

One of the great advantages of Roth IRAs is that they aren’t subject to the same RMD rules. If you have a Roth IRA, you don’t have to take RMDs during your lifetime. 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 from the inherited Roth IRA.

Are Pensions Subject to Lifetime Required Minimum Distributions?

IRAs aren’t the only retirement savings vehicles subject to RMDs. The lifetime RMD rules generally apply to the following types of pension plans:

  • Corporate and self-employed pension, profit-sharing, and stock-bonus plans qualified under IRC Sec. 401(a). This includes Keogh or H.R. 10 plans, 401(k) plans, and employee stock ownership plans or ESOPs.
  • Simplified Employee Plans (SEPs) under IRC Sec. 408(k)
  • Tax-sheltered annuities under IRC Sec. 403(b) (except for account balances existing on Dec. 31, 1986, if kept separate for accounting purposes).

What are the Required Minimum Distributions for Roth Beneficiaries?

If you have a Roth IRA, you don’t have to take RMDs during your lifetime. However, Roth IRAs are subject to RMD rules after you pass away and your beneficiary inherits the account. There’s a 50% penalty (an “excise tax”) if the distributions aren’t made, so it pays to understand the rules—and make sure your beneficiaries do, as well.

When a Spouse Is the Sole Beneficiary

If you inherit your spouse’s Roth IRA as the sole beneficiary, you have several options:

  • 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. In this case, you transfer the assets into an inherited IRA in your name. You have to take RMDs, stretched over your life expectancy. But you can postpone distributions until your spouse would have reached age 70 1/2, or Dec. 31 of the year after your spouse passed away. Distributions aren’t taxed if the 5-year rule has been met.
  • Open an inherited IRA: 5 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 aren’t taxed if the 5-year rule has been met.
  • Lump-sum distribution. In this case, all 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.
When Someone Else Is the Beneficiary

If you inherit a Roth IRA from a friend or non-spouse family member, you have these options:

  • Open an inherited IRA: Life Expectancy Method. You transfer the assets into an inherited IRA in your name. You have to start taking RMDs by Dec. 31 of the year following the previous account holder’s death. Distributions are stretched over your life expectancy and aren’t taxed if the 5-year rule has been met.
  • Open an inherited IRA: 5 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 following the previous account holder’s death. Distributions aren’t taxed if the 5-year rule has been met.
  • Lump-sum distribution. The Roth IRA assets are distributed to you all at once. If the account was less than five years when the account holder died, the earnings will be taxable.

Tax-Free Growth, Tax-Free Income

A Roth IRA can be an excellent wealth transfer vehicle because you don’t have to take RMDs during your lifetime, and distributions are generally tax-free.

One challenge with the Roth IRA RMD rules is that your beneficiaries may not know they have to take distributions. If you have a Roth IRA, do your beneficiaries a favor. Let them know they may need to take distributions—or face a 50% penalty on amounts that should have been distributed. 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.

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