Weller Group LLC Timothy Weller, CFP CERTIFIED FINANCIAL PLANNER 6206 Slocum Road Ontario, NY 14519 315-524-8000 tim@wellergroupllc.com www.wellergroupllc.com Beneficiary Designations for Roth IRAs Page 1 of 8, see disclaimer on final page
Beneficiary Designations for Roth IRAs Introduction When you establish a Roth IRA, you're generally required to complete a beneficiary designation form with your Roth IRA custodian or trustee. The beneficiary (or beneficiaries) you name will receive the remaining funds in your Roth IRA after you die. Although choosing a beneficiary may seem straightforward, there are actually several tax and nontax points to consider--and the beneficiary decisions you make now may have significant consequences in the future. Whether you have a Roth IRA or a traditional IRA, your primary goal should be to choose beneficiaries for whom you want to provide. Because Roth IRAs are different from traditional IRAs, though, the considerations for choosing beneficiaries may differ. Unlike traditional IRAs, Roth IRAs are not subject to the lifetime required minimum distribution (RMD) rules (however, your beneficiaries will be required to take distributions after you die). In addition, qualified distributions paid to your Roth IRA beneficiaries are free from income tax. Tip: It's important for your beneficiaries to receive professional tax advice as soon as practical after your death so that they may be informed of all of the options available to them and apprised of the time limits for making beneficiary-related decisions. You should also seek professional advice before making a Roth IRA beneficiary designation, because there may be income tax and estate tax consequences associated with your choice. You don't have to take required minimum distributions from a Roth IRA during your lifetime If you have a traditional IRA, federal law generally requires that you begin taking annual RMDs from your account by April 1 of the calendar year following the calendar year in which you reach age 70½ (your "required beginning date"). In some limited cases, your choice of beneficiary can affect the way these RMDs are calculated. By contrast, Roth IRAs are not subject to the RMD rules while you're alive. Consequently, if you don't need income from your Roth IRA, or if you want to preserve the funds for your beneficiaries, you don't have to take distributions from your Roth IRA during your lifetime. And if you do choose to take distributions, you need not follow a set schedule--you're free to withdraw as much (or as little) as you like, regardless of the beneficiaries you have named for your Roth IRA. With a Roth IRA, your choice of beneficiary has no impact on the distributions you take (or decide not to take) while you're alive. Qualified Roth IRA distributions are free from income tax Unlike traditional IRAs, certain distributions from Roth IRAs may be completely free from income tax. To be free from federal income tax, a Roth IRA distribution must be considered a qualified distribution. A distribution is qualified if a five-year holding period has been satisfied, and if at least one of the following also applies: You've reached age 59½ at the time of the distribution The distribution is made because of a qualifying disability The distribution is made to pay qualifying first-time homebuyer expenses ($10,000 lifetime limit) The distribution is made to your beneficiary or estate after your death So, if you own a Roth IRA, distributions made after your death to a beneficiary (or to your estate) will be free from federal income tax if the five-year holding period is satisfied. The five-year period is measured in tax years, beginning with the tax year for which your first contribution was made to any Roth IRA (or, if earlier, the tax year in which you converted a traditional IRA to a Roth IRA). For instance, if you made your first Roth IRA contribution on April 15, 2013 (for the 2012 tax year), your contribution is treated as having been made on January 1, 2012, for purposes of the five-year rule. Distributions made on or after January 1, 2017, therefore, are considered qualified distributions. (That's because they weren't made within the five-year period of January 1, 2012 to December 31, 2016.) As long as your beneficiary doesn't take distributions from the inherited Roth IRA until after the five-year period has passed, the distributions will escape federal income taxation. Tip: A single five-year holding period applies to all Roth IRAs you own for purposes of determining whether or not a distribution is Page 2 of 8, see disclaimer on final page
qualified. You don't determine a separate five-year holding period for each Roth IRA. Caution: A surviving spouse who treats a deceased spouse's Roth IRA as his or her own must independently satisfy the criteria for a qualified distribution. That is, the distribution must satisfy the five-year rule (see technical note below), and must be made either after the surviving spouse (not the deceased spouse) attains age 59½, dies, becomes disabled, or incurs qualifying first-time homebuyer expenses. Technical Note: A surviving spouse who treats a deceased spouse's Roth IRA as his or her own gets to use the earlier of the deceased spouse's Roth IRA contribution date or his or her own Roth IRA contribution date in determining the starting point of the five-year holding period, for both the inherited Roth IRA and any other Roth IRA the surviving spouse owns. See Treas. Reg. Section 1.408A-6, A-7(b). Nonqualified distributions may (or may not) be taxable If a beneficiary takes a distribution within the five-year holding period, the distribution is considered a nonqualified one. Special rules determine how nonqualified distributions are taxed (or not taxed) for federal income tax purposes. Because Roth IRAs are generally funded with after-tax contributions, the portion of a distribution that represents your contributions to the Roth IRA is never taxable. However, the investment earnings portion of a nonqualified distribution is subject to income tax. Roth IRA distributions are considered to consist of contributions first and earnings last. If a beneficiary must take nonqualified distributions, therefore, he or she can withdraw all of your contributions tax free before tapping into the taxable earnings (it gets more complicated if you've converted a traditional IRA into a Roth IRA). Example(s): Bob contributed $3,000 to his first Roth IRA in 2013 for the 2013 tax year. In 2014, he contributes another $3,000 for the 2014 tax year. Now say Bob dies in 2015. The Roth IRA will pass to the designated beneficiary of Bob's Roth IRA, Bob's brother Al. If Al takes a $3,000 distribution from the Roth IRA in 2014, it will not be a qualified distribution since the five-year period does not end until December 31, 2017 (January 1, 2013 through December 31, 2017). However, even though it will not be a qualified distribution, Al's $3,000 distribution will be considered to consist of Bob's contributions and will therefore not be taxable. Because Bob will have contributed a total of $6,000 before his death, Al will be able to take another $3,000 distribution within the five-year period and still owe no federal income tax. Any amount distributed on or after January 1, 2018, including earnings, will be considered a qualified distribution and will be free from income tax. Tip: The federal 10 percent premature distribution tax that may apply to premature Roth IRA distributions (i.e., nonqualified distributions taken before age 59½) does not apply to post-death distributions, regardless of your beneficiary's age or your age at the time of your death. Your beneficiaries must take timely post-death distributions from the Roth IRA to avoid penalties Although you aren't required to take lifetime distributions from your Roth IRA, the beneficiaries of your IRA will generally be required to take "required minimum distributions" (RMDs) from the account after you die. The distribution methods available to your beneficiaries are similar to the options available to traditional IRA beneficiaries (using the rules that apply for deaths prior to the taxpayer's required beginning date). (Note that special rules apply to surviving spouses who are beneficiaries.) Your nonspousal beneficiaries will have to take post-death distributions according to one of the following methods: The life expectancy method The five-year rule Caution: No matter which payout method is selected for post-death distributions, a beneficiary can choose to receive more than the required amount in any given year. However, if a beneficiary receives less than the required amount in any given year, he or she will be subject to a federal penalty tax. This penalty tax is equal to 50 percent of the difference between the required distribution and the amount actually distributed. (This is the same penalty tax that may apply to required lifetime and post-death distributions from a traditional IRA.) Life expectancy method A designated beneficiary can generally take distributions over his or her remaining single life expectancy, beginning no later than December 31 of the year following the year of your death. If there is more than one designated beneficiary, the age of the oldest Page 3 of 8, see disclaimer on final page
beneficiary (i.e., the one with the shortest life expectancy) must be used to calculate the distributions. (Exception: If separate accounts are established for each beneficiary, distributions will be calculated separately for each account.) Five-year rule A designated beneficiary can generally take distributions according to the five-year rule. Under this method, distributions are taken over a five-year period ending on December 31 of the year during which the fifth anniversary of your death occurs. The beneficiary has discretion over the timing and amount of distributions, as long as all of the funds are distributed within the applicable five-year period. Four critical dates for taking action When planning for post-death distributions, your beneficiaries must pay particular attention to four dates: (1) nine months after your death, (2) September 30 of the year following the year of your death, (3) October 31 of the year following the year of your death, and (4) December 31 of the year following the year of your death. Each of these dates may have a tax decision or requirement associated with it. To be valid, a disclaimer (refusal to accept benefits) must be signed by a beneficiary and meet other requirements no later than nine months after your death. Therefore, even though the designated beneficiaries are determined on September 30 of the year following the year of your death, a disclaimer may need to be signed much earlier to meet the nine-months-after-death rule. If a beneficiary makes such a valid disclaimer, the IRA funds will generally pass to any other primary beneficiary(ies) or to the designated contingent beneficiary (if there is one). September 30 of the year following your death is the day to finalize who are the "designated beneficiaries." IRS regulations mandate that IRA beneficiary designations are final as of September 30 of the year following the year of your death. Only beneficiaries remaining on that date will be included when determining post-death distributions from the Roth IRA. October 31 of the year following the year of your death is the deadline for furnishing documentation relating to a trust as a beneficiary. If the life expectancy method is selected, distributions must begin by December 31 of the year following the year of your death. If the distributions don't begin by that date, your beneficiaries can't use the life expectancy method, and the five-year rule becomes the default payout method. Caution: Although the date for finalizing beneficiaries for distribution purposes is September 30 of the year following the year of your death, an IRA or plan account can be split into separate accounts up until December 31 of that same year. If separate accounts are established, each account is treated separately for purposes of determining post-death distributions. Due to the inconsistency between the September 30 and December 31 dates, it may be advisable to create separate accounts by September 30 rather than waiting until December 31. The rules governing separate accounts are complex. For more information, consult a tax professional. Special options available to spousal beneficiaries Special distribution options may be available to surviving spouse beneficiaries (discussed below). Your options when choosing Roth IRA beneficiaries Who can you designate as your Roth IRA beneficiary? Basically, you have the same options that the owner of a traditional IRA has. Because Roth IRAs are different from traditional IRAs, though, some special considerations may apply. Your beneficiary choices generally include the following options. Tip: For general information on multiple beneficiaries, primary and secondary beneficiaries, "designated" beneficiaries versus "named" beneficiaries, and other issues, see our separate topic discussion, Beneficiary Designations for IRAs and Retirement Plans. Surviving spouse If your surviving spouse is the sole designated beneficiary of your Roth IRA, he or she will have certain options that are not available to other types of beneficiaries. For instance, your surviving spouse can generally elect to be the new account owner of the inherited Roth IRA. Alternatively, your surviving spouse can generally elect to roll over the inherited funds to his or her new or existing Roth IRA. In either case, the inherited funds will be in a Roth IRA in your surviving spouse's own name. (Other types of beneficiaries must withdraw from the Roth IRA that is in your name.) This outcome is significant for two reasons: Page 4 of 8, see disclaimer on final page
As a Roth IRA owner, your surviving spouse can name new beneficiaries of his or her choice (your children, for example). These new beneficiaries will receive the funds remaining in the Roth IRA after the death of your surviving spouse. By having new beneficiaries, the period of time for the tax-free accumulation of earnings in your Roth IRA is extended (subject to the post-death RMD rules, of course). Caution: You may not be happy that your spouse has this discretion to change beneficiaries, especially if you have children from a prior marriage or you are concerned that your spouse might remarry and name the new spouse as the primary beneficiary. As a Roth IRA owner, your surviving spouse will not be subject to the lifetime RMD rules. He or she can take distributions from the account if desired, but there is no requirement that he or she do so. This creates the opportunity to preserve the funds in a tax-advantaged environment for the new beneficiaries. Of course, these are not the only options available to a surviving spouse beneficiary. Your surviving spouse can also elect to disclaim the inherited Roth IRA funds, or take post-death distributions under the life expectancy method or the five-year rule. (In most cases, though, it will be in a surviving spouse's best interest to exercise one of the unique spousal options.) A child, grandchild, or other individual You may want to name your child, grandchild, or other individual as the beneficiary of your Roth IRA. As mentioned, a nonspousal beneficiary must take the Roth IRA distributions in one of the following two manners: By the end of the year during which the fifth anniversary of the account owner's death occurs, or Over the remaining single life expectancy of the beneficiary, with the first distribution starting no later than December 31 of the year following the year that the account owner died If you designate a grandchild or other young beneficiary for your Roth IRA, he or she may be able to take post-death distributions over a long payout period using the life expectancy method. This could maximize tax-advantaged growth opportunities by allowing some of the funds to stay in the Roth IRA for many years. And unlike a traditional IRA, post-death Roth IRA distributions may be free from income tax. Caution: If you name your grandchild as IRA beneficiary and have a substantial estate, the generation-skipping transfer tax (GSTT) may be an issue. Before naming any beneficiary, consider consulting a tax planning or estate planning professional for more information. A trust You can name a qualifying trust as the beneficiary of your Roth IRA if the IRA custodian or trustee allows such a designation. If all requirements are met, the beneficiaries of the trust can be treated as the designated beneficiaries of the Roth IRA. When a qualifying trust is the beneficiary of a Roth IRA, post-death distributions are calculated based on the life expectancy of the oldest trust beneficiary, which can reduce the time that distributions can be spread out. Suppose, for example, you name your 70-year-old brother and your 10-year-old grandchild as co-beneficiaries under a trust. For distribution purposes, your grandchild must use your 70-year-old brother's life expectancy (since your brother is the oldest beneficiary). Therefore, your grandchild will lose the deferral of payouts that could occur if his or her life expectancy were used instead. Still, a trust can be an especially useful tool if you want your children (or other individuals) to benefit from your Roth IRA, but want to maintain some control over their access to the funds. Tip: You may be able to establish separate trusts to enable each beneficiary to use his or her life expectancy when calculating required post-death distributions. Consult an estate planning attorney. Caution: There are costs associated with establishing and administering a trust, including the cost of retaining an attorney for advice and to draw up the trust agreement. A charity You may name a charity as the beneficiary of your Roth IRA. Such a move may be especially attractive if you don't have any loved ones, or if you want to benefit your loved ones through other means. From an income tax standpoint, though, it's not always advisable to name a charity as your Roth IRA beneficiary. Because a qualified charity is a tax-exempt entity, the benefit of income-tax-free Roth IRA distributions is wasted on the charity. It may make more sense to benefit a loved one with the income-tax-free Roth IRA distributions, and leave a traditional IRA or other taxable assets to your favorite charity. (The Page 5 of 8, see disclaimer on final page
beneficiaries of a traditional IRA usually have to pay income tax on their distributions. Because a qualified charity is tax exempt, though, the charity would receive the distributions tax free.) With charities, the five-year rule is used to take post-death distributions (i.e., all distributions will be taken on or before the end of the year during which the fifth anniversary of the account owner's death occurs). Your estate If you name your estate as the beneficiary of your Roth IRA, the money in the account first goes to your estate, and then what's left passes to your heirs according to the terms of your will (if you have one) or through the laws of intestacy. Naming your estate as beneficiary is usually not advisable. First of all, you sacrifice some planning options. Secondly, the Roth IRA will have to pass through the probate process instead of going directly to your loved ones; this can be costly and protracted. And, it can unnecessarily expose your Roth IRA to creditors. Finally, you may not be able to stretch distributions out over the lifetime of an individual beneficiary. Generally, the five-year rule will apply. Why your choices matter There are several factors you may want to consider when selecting beneficiaries for your Roth IRA. Although your primary concern may be to provide financial security for your loved ones, you should also take into account the ages and needs of your loved ones. In addition, you should keep the Roth IRA distribution rules in mind, as well as the beneficial income tax treatment that the Roth IRA may afford. Because choosing a Roth IRA beneficiary is an important decision, you may want to select a beneficiary with the help of a tax advisor or other qualified professional. In addition, you should review your beneficiary choices periodically to ensure that they continue to be appropriate, since your financial and personal circumstances (and those of your beneficiaries) may change over time. Fortunately, you'll generally be free to add or remove beneficiaries whenever you want (though certain restrictions may apply). Income tax considerations As discussed, if the five-year holding period is satisfied, your beneficiaries will not have to pay income tax on your Roth IRA funds after you die. Moreover, funds left in a Roth IRA continue to accumulate free from income tax. So, the longer the funds remain there, the more your beneficiaries may benefit from tax-free growth. This is where your choice of beneficiary can play a critical role; your beneficiary designation may determine (in part) how long the funds can remain in the Roth IRA after your death. Estate tax considerations Your Roth IRA beneficiary choice may also impact your federal estate tax situation. Estate taxes may be a concern if you expect the value of your estate to exceed the applicable exclusion amount. The full value of your Roth IRA will be included with your other assets to determine how much (if any) federal estate tax is due from your estate. One potential estate-tax-saving strategy may be to name your spouse as the beneficiary of your Roth IRA and other assets. The federal marital deduction allows you to leave unlimited assets to your spouse free from estate tax. Caution: By leaving all of your assets to your spouse, you may waste your applicable exclusion amount. You may defer estate taxes, but when your surviving spouse dies, his or her federal estate tax liability may be higher than necessary. Consult an estate planning attorney for more information. To take full advantage of both the unlimited marital deduction and both spouses' applicable exclusion amounts, a better strategy may be to leave some of your assets in trust for your spouse and to leave some assets to other beneficiaries (such as children or grandchildren). Having a potentially income-tax-free Roth IRA in a death-tax-saving trust may make more sense than having a taxable traditional IRA in there. Another possibility is to leave your Roth IRA and/or other assets to charity, allowing your estate to benefit from a charitable deduction. Estate planning for retirement assets is complex. Consult an estate planning attorney about appropriate strategies to minimize estate taxes, and about how your Roth IRA should fit into your overall estate plan. State law considerations You must also consider how state law may affect your Roth IRA. Your spouse may have legal rights in your Roth IRA regardless Page 6 of 8, see disclaimer on final page
of whether he or she is named as the primary beneficiary. In addition, if your roles are reversed (your spouse is the Roth IRA owner, and you are the primary beneficiary) and you die first, state law may prevent your surviving spouse from changing the beneficiary designation after your death regarding your interest in the assets (unless you grant your spouse the power to make these changes in a will or other document). Caution: States may differ in their income tax and estate tax treatment of Roth IRA distributions. You should consult an estate planning attorney for details regarding these and other state-specific issues. Page 7 of 8, see disclaimer on final page
The accompanying pages have been developed by an independent third party. Commonwealth Financial Network is not responsible for their content and does not guarantee their accuracy or completeness, and they should not be relied upon as such. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Commonwealth does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2015. Securities and advisory services offered through Commonwealth Financial Network, member FINRA/SIPC, a Registered Investment Adviser. Weller Group LLC Timothy Weller, CFP CERTIFIED FINANCIAL PLANNER 6206 Slocum Road Ontario, NY 14519 315-524-8000 tim@wellergroupllc.com www.wellergroupllc.com Page 8 of 8 Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2017