The Impact of RMDs and the SECURE Act on Inherited Roth IRAs

Required Minimum Distributions (RMDs) for Roth IRAs: A Historical Perspective

Roth Individual Retirement Accounts (IRAs) were introduced in 1997 as a new type of retirement account that allows investors to save after-tax dollars and enjoy tax-free withdrawals in retirement. Compared to traditional IRAs, which offer immediate tax deductions but require taxes on withdrawals at retirement, Roth IRAs are more appealing to some investors who expect their future tax rates to be higher than their current ones.

One key advantage of Roth IRAs is that they do not have Required Minimum Distributions (RMDs) during the account owner’s lifetime. RMDs are mandatory annual withdrawals from traditional IRAs and other qualified retirement plans starting at age 72 (formerly age 70½), based on IRS life expectancy tables. Failure to take RMDs can result in substantial penalties, up to 50% of the amount not withdrawn.

However, there was a major change in the rules governing RMDs for inherited IRA beneficiaries with the enactment of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in December 2019. Under the old rules, non-spouse beneficiaries could stretch out RMDs over their own lifetimes and potentially extend tax deferral for decades. But now, most non-spouse beneficiaries must withdraw all assets from an inherited IRA within ten years following the death of the original account owner.

This change affects both traditional and Roth IRAs, although it may not impact Roth IRA owners directly since they were already exempt from RMDs themselves. However, it does affect anyone who wants to pass on their Roth IRA assets to heirs or charities after they die.

For example, if you name your child as a beneficiary of your Roth IRA under the new rules, he or she would have ten years after your death to withdraw all funds from that account without triggering taxes or penalties. This compressed timeline may cause a significant tax hit if the beneficiary is in a high-income year or if the Roth IRA has grown substantially over time.

One way to mitigate this impact is to convert some or all of your traditional IRA balances into Roth IRAs before age 72, when RMDs would have started. By doing so, you can reduce your future taxable income and avoid RMDs altogether while still enjoying tax-free withdrawals in retirement. Additionally, converting traditional IRAs into Roth IRAs also reduces the size of the estate that may be subject to estate taxes upon death.

In conclusion, although Roth IRAs do not require RMDs during your lifetime and offer tax-free withdrawals in retirement, there are important changes to how inherited Roth IRAs are treated under the SECURE Act that could affect your heirs’ taxation planning. Consult with a financial advisor or tax professional to see whether converting traditional IRAs into Roth IRAs makes sense for you based on your individual circumstances and goals.