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Wednesday, April 20, 2016

IRS Biased Against Inherited Roth IRAs

The IRS should not be biased against inherited Roth IRAs, but the IRS is. Some IRS administrations are more biased against inherited Roth IRAs than others.

The IRS does not like the fact that a person may inherit a Roth IRA and earn tax-free income over the beneficiary’s life expectancy. This will be accomplished if the beneficiary limits his or her distributions to the required amount each year using the life distribution rule. This will not be accomplished if the 5-year rule is used.

The IRS last revised model Form 5305-RA in March of 2002. In Article V it is clearly stated that a beneficiary will use the life distribution rule to comply with the required distribution rules unless he or she elects the 5-year rule. The 5-year rule applies automatically if there is no designated beneficiary (e.g. the estate is the beneficiary).

Article V

1. If the depositor dies before his or her entire interest is distributed to him or her and the depositor’s surviving spouse is not the designated beneficiary, the remaining interest will be distributed in accordance with (a) below or, if elected or there is no designated beneficiary, in accordance

with (b) below:

(a) The remaining interest will be distributed, starting by the end of the calendar year following the year of the depositor’s death, over the designated beneficiary’s remaining life expectancy as determined in the year following the death of the depositor.

(b) The remaining interest will be distributed by the end of the calendar year containing the fifth anniversary of the depositor’s death.

The IRS in Publication 590-B (Distributions from IRAs), page 36, gives murky guidance discussing distributions after the Roth IRA owner’s death. “Generally, the entire interest in the Roth IRA must be distributed by the end of the fifth calendar after the year of the owner’s death unless the interest is payable to a designated beneficiary over the life or life expectancy of the designated beneficiary.” The IRS could and should be informing a Roth IRA beneficiary that if he or she elects to use the 5-year rule that one loses the right to earn tax-free income and therefore most beneficiaries should use the life distribution rule.

In recent years the IRS has adopted rules and procedures to be more fair and transparent. At times the IRS has a great conflict of interest and should make this known. The IRS should revise its discussion of inherited Roth IRAs to not try to induce a beneficiary to use the 5-year rule.

Posted by James M. Carlson at 15:01.57
Categories: Roth IRAs