The rules for an inherited Roth IRA are based on who the beneficiary is. That's because there are different rules for distributions, when the beneficiary is a spouse or a child or a charity.
You need to understand the rules to avoid the getting hit with a severe penalty for failing to make a required distribution, advises nj.com in its recent article, “The rules for Inherited Roth IRAs.”
One of the attractive features of a Roth IRA is that while the original owner is alive, there are no Required Minimum Distributions (RMDs). As a result, the Roth IRA can continue to grow tax-free for a very long time.
However, when the beneficiary dies, the rules change. If a spouse is the beneficiary of an inherited Roth IRA, the spouse can roll over the Roth into the spouse's name and continue to allow the funds to grow tax-free with no RMDs during the inheriting spouse's lifetime.
If the spouse doesn’t rollover the Roth IRA, but rather treats it as an inherited Roth IRA, he or she must make required distributions as soon as the spouse reaches age 70½.
If a child or grandchild is the beneficiary, he or she must withdraw the funds over his or her lifetime.
With a younger beneficiary, such as a grandchild, he or she will enjoy more time before he or she must withdraw the money, increasing the value of the Roth.
Unlike a traditional IRA, a distribution from a Roth IRA doesn’t trigger an income tax.
If the beneficiary is a charity or the owner's estate, or if the owner fails to name a beneficiary, the entire Roth IRA is subject to the five-year rule. That means that the entire Roth IRA must be distributed over the five years, following the death of the owner.
There's one more issue to look at: if, at the death of the Roth IRA owner, the funds haven’t been held in the Roth IRA for at least five years, the earnings on the funds will be taxable to the beneficiary. However, there’s no penalty for an early withdrawal.
Reference: nj.com (February 2, 2018) “The rules for Inherited Roth IRAs.”