Definition: How do inherited Roth IRAs differ from inherited traditional IRAs?

Inherited Roth IRAs and inherited traditional IRAs are two types of retirement accounts that individuals can inherit from a deceased account holder. While both types of IRAs offer tax advantages, there are key differences between them.

Tax Treatment

One of the main differences between inherited Roth IRAs and inherited traditional IRAs lies in their tax treatment. Inherited Roth IRAs are funded with after-tax contributions, meaning that the original account holder has already paid taxes on the contributions. As a result, qualified distributions from inherited Roth IRAs are generally tax-free for the beneficiary.

On the other hand, inherited traditional IRAs are funded with pre-tax contributions, which means that the original account holder has not paid taxes on the contributions. When a beneficiary withdraws funds from an inherited traditional IRA, they are typically subject to ordinary income tax.

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Required Minimum Distributions (RMDs)

Another difference between inherited Roth IRAs and inherited traditional IRAs is the requirement for beneficiaries to take required minimum distributions (RMDs). Inherited traditional IRAs require beneficiaries to start taking RMDs by December 31st of the year following the original account holder’s death. The amount of the RMD is based on the beneficiary’s life expectancy and is subject to income tax.

However, inherited Roth IRAs do not require beneficiaries to take RMDs during their lifetime. This allows the funds to continue growing tax-free for an extended period, providing potential long-term benefits for the beneficiary.

Conversion Options

One advantage of inherited Roth IRAs is the potential for conversion. If a beneficiary inherits a traditional IRA, they have the option to convert it into a Roth IRA. By doing so, the beneficiary can take advantage of the tax-free growth and tax-free qualified distributions offered by Roth IRAs.

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However, it is important to note that converting an inherited traditional IRA to a Roth IRA will trigger a taxable event, as the pre-tax contributions will be subject to income tax in the year of conversion.

Impact on Estate Planning

When it comes to estate planning, inherited Roth IRAs and inherited traditional IRAs can have different implications. Inherited Roth IRAs are not subject to estate tax, as the original account holder has already paid taxes on the contributions. This can be advantageous for beneficiaries who want to minimize their estate tax liability.

On the other hand, inherited traditional IRAs are included in the deceased account holder’s estate and may be subject to estate tax. This can potentially reduce the amount of funds available to the beneficiary.

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In summary, inherited Roth IRAs and inherited traditional IRAs differ in their tax treatment, required minimum distributions, conversion options, and impact on estate planning. Understanding these differences can help beneficiaries make informed decisions about managing their inherited retirement accounts.

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