So you’ve just inherited a Roth IRA, and it’s a lot of money. You’re nervous about it because you want to make sure you do the right thing. Well, here are a few things to keep in mind.
Is there a will?
A will won’t make a difference in all cases, but it might give some insight on how the benefactor wanted the funds handled.
For example, if a beneficiary is listed on the account, a will won’t matter. But if there isn’t a designated beneficiary, a will might be used to determine the ownership of the account.
Are you the beneficiary?
If you are the only person listed as the beneficiary, then you will have several options. The money is yours, and ownership of the account will be transferred directly to you.
On the other hand, if there are multiple beneficiaries, the funds will be divided up according to the percentages designated for each person.
If there is no beneficiary at all, then the process is more complicated and will take longer to access the funds (a will might be used to determine ownership in that case).
If there is no will, and no designated beneficiary, then the funds are paid to the estate and will be handled accordingly.
When a beneficiary is listed, that certainly makes things a easier. But the type of beneficiary also matted.
There are basically two types of beneficiaries: spousal and non-spousal.
Options as a spouse
If you inherit a Roth IRA as a spouse, you basically have three options.
1. Spousal transfer (best option)
With a spousal transfer, the Roth IRA basically becomes your own (no other beneficiaries are listed) as if you started it to begin with.
You can assume the Roth IRA as your own, or you can roll it into a new Roth IRA (or an existing one). The same rules apply as if it were yours to begin with.
The money continues to grow tax-free, and there are no minimum distributions required.
If you are the spouse of an inherited Roth IRA, but not the only beneficiary, you will have to go with options 2 or 3.
2. Open an inherited IRA
This option allows you to open an inherited IRA. Keep in mind that you won’t be able to transfer the funds into your own Roth IRA because there are other rules that apply.
No minimum distributions are required, but you won’t be able to make contributions to it, either.
3. Take distributions
Since the money is yours now, you are free to do with it whatever you want – including cashing it out entirely.
In most cases, the money is tax-free, but there are some exceptions.
Distributions of any amount are allowed, but taxes will be owed if the original account is less than 5 years old.
Options as a non-spouse
If you are a non-spouse (family member or friend), you basically have two options if you inherit a Roth IRA.
1. Open an inherited IRA (best option)
If you open an inherited IRA account, you will have to deplete the funds within 10 years.
You will not be able to make contributions to it, but it will continue to grow tax-free for up to 10 years.
There are a few exceptions to the 10 year rule:
- Children who are minors (the 10 year rule starts once the child is 18 years old).
- Children who are chronically ill or disabled (distributions can be stretched over their lifetime).
- People who are within 10 years old of the account holder (distributions can be stretched across their lifetime).
2. Cash it out
If you choose to take distributions, there’s no limit on when or how often. As long as the funds are depleted within 10 years, you’re good to go.
You can leave the funds alone and allow them to continue to grow and then take them out after 10 years; you can take the funds out now; or you can take the funds out overtime. As long as the funds are depleted within 10 years, you can take distributions however you’d like.
Here are a few things you could use the funds for when trying to deplete them within the 10 year rule:
- Pay off debt
- Buy a car
- Buy a house
- Buy rental properties
- Pay medical bills
- Donate to charities
- Pay for vacations
- Start a business
I suppose the options are endless; those are just a few that come to mind.
But, ultimately, it’s up to you. After all, the money is yours now. You can spend it however you want.
Related: 11 Benefits of Being Frugal
Get expert advice
Still unsure of what to do? Get advice from a professional.
Any financial advisor can walk you through your options. Even if you have an idea of what you want to do with the money, it never hurts to get a second opinion, especially from experts in the field.
Honor their legacy
One thing you might want to keep in mind is, “How can I honor the legacy of the person who left the inheritance?”
Perhaps they have a will, or maybe they left an idea of what they would like you to do with the money. Maybe you should honor that.
Doing so might bring more than just financial peace. It might give you peace of mind.
Did the person who left you the inheritance want you to avoid debt, be charitable, and have a better chance than they did?
Whatever you choose, make sure it brings honor to the person who left it. You have an opportunity to make them proud, so choose wisely.
If you inherit a Roth IRA, and you are not the spouse, it’s probably best to open an inherited IRA, so you can stretch out the distributions as long as possible. This gives you plenty of time to decide what to do with the funds, while also taking out the smallest amounts possible. This allows the inheritance to grow and make more than it would have otherwise.