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Roth IRAs and Required Minimum Distribution (RMD) Rules Explained

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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One of the biggest benefits of the Roth IRA is there are no required minimum distributions (RMDs). With traditional IRAs, account holders are required to begin taking RMDs when they reach 70 and a half.

Roth IRAs, however, are funded with money that has already been taxed, which means there is no RMD for the primary account holder. Although the primary account holder is free from RMDs, there are still additional rules governing the withdrawal of funds from Roth IRAs.

Here’s what you need to know about the distribution rules for Roth IRAs.

Do Roth IRAs have RMDs?

Roth IRAs do not require account holders to take required minimum distributions at any time, but there are various rules governing your ability to withdraw funds from a Roth IRA.

To start, there are both age and timing limitations for when an account holder can take distributions from a Roth IRA without penalties. Specifically, account holders must have reached the age of 59 and half, and have had their Roth IRA open for a minimum of five years prior to their first withdrawal in order for that distribution to be exempt from penalties. For instance, if you open a Roth IRA at the age of 57, you’ll have to wait until you are 62 years old to make a penalty-free distribution, known as the five-year rule.

Additionally, while account holders are not subject to RMDs, anyone who inherits a Roth IRA from the primary account holder must follow specific rules about distributions — or face a painful tax penalty.

Inherited Roth IRAs and required minimum distributions

The IRS has rules for spousal and non-spousal heirs of Roth IRAs, and the specific rules depend on whether the account holder had opened the account at least five years before his or her death.

Inheriting a Roth IRA from your spouse

A surviving spouse is allowed to take over the deceased spouse’s Roth IRA as the account holder. Doing this ensures there will be no RMDs for the surviving spouse’s lifetime. The Roth IRA will simply be an account that the surviving spouse may access if he or she chooses.

A surviving spouse may also take distributions from their Roth IRA, although the rules change depending on whether or not the Roth IRA meets the five-year rule.

Roth IRA inheritance meets the 5-year rule

Let’s say Arthur passed away 20 years after opening his Roth IRA and named his wife, Arabella, as his beneficiary. Arabella will not face RMDs and will have a few options once she takes over the account.

One option is to take distributions spread out over her lifetime. To do this, Arabella will use the IRS Table I: Single Life Expectancy Table. To determine her annual distribution amount, she will divide the Roth IRA balance by the distribution period listed on Table I for her current age. For instance, if Arabella is 76, her life expectancy is 12.7 years, and she will divide the account balance by 12.7 to calculate this year’s distribution amount.

Alternatively, Arabella could also take distributions based upon Arthur’s age. In this case, she would use Arthur’s age in the year he died and compare it to Table I. So if Arthur turned 74 the year he died, his life expectancy was 14.1 years. She will then divide the Roth IRA balance by 14.1 and use that as her first-year distribution amount. The following year, she will take a distribution as if Arthur were 75, and continue to increase his “age” for each subsequent year.

Roth IRA inheritance does not meet the 5-year rule

What if Arthur died less than five years after opening his Roth IRA? Arabella will still have three options, but they are slightly different:

First, Arabella would still have the option of treating the Roth IRA as her own. She may also take distributions based upon Arthur’s age, but she would not be able to take distributions based upon her own age. One additional option available is to withdraw the entire balance by the end of the fifth year following Arthur’s death.

Spousal options for inherited Roth IRAs

Account holder met five-year ruleAccount holder did not meet five-year rule
Spouse treats Roth IRA as his or her ownSpouse treats Roth IRA as his or her own
Spouse takes distributions over his or her lifetime, based upon current ageSpouse takes distributions based upon deceased spouse’s age
Spouse takes distributions based upon deceased spouse’s ageSpouse withdraws entire balance by end of fifth year following the year of death

Non-spousal inheritance of Roth IRA

If you are the beneficiary of a Roth IRA from a parent, sibling, or other individual who is not your spouse, your options are a little more limited. The IRS does not allow non-spouse heirs to treat an inherited Roth IRA as their own, so you will face some sort of required minimum distribution.

Again, the options are different depending on whether the Roth IRA meets or does not meet the five-year rule:

Roth IRA meets the 5-year rule

Let’s say Phillip passed away at the age of 80, leaving his Roth IRA to his 50-year-old son Colin, and his 47-year-old daughter Margaret. Phillip died after holding the Roth IRA for more than five years.

The only option available to Colin and Margaret is to take life expectancy distributions. They can determine those distributions based upon the youngest of the two options: their own ages at the end of the year following Phillip’s death, or Phillip’s age as of his birthday in the year that he died.

Obviously, Colin and Margaret are younger than their father and must take distributions based upon their own ages. However, if there are multiple beneficiaries, the IRS requires them to take distributions based upon the age of the oldest beneficiary. That means Colin and Margaret must take annual distributions based on Colin’s age.

Roth IRA does not meet the 5-year rule

If a Roth IRA account holder passes away before holding the account for five years, that changes the options available for a non-spousal heir. For instance, let’s say Emma opened a Roth IRA three years before she passed away, and named her brother, Bromley, as the beneficiary.

Like Colin and Margaret, Bromley has the option of taking life expectancy distributions. However, because Emma’s Roth IRA does not meet the five-year rule, he must base his distributions on his own age, rather than the younger of his or Emma’s age.

Bromley also has the option of taking the entire balance of the Roth IRA as a distribution by the end of the fifth year after Emma’s death.

Non-spousal options for inherited Roth IRAs

Account holder met five-year ruleAccount holder did not meet five-year rule
Beneficiary takes distributions over his or her lifetime, based upon current age or account holder’s age at death, whichever is younger. Multiple beneficiaries must take distributions based upon the oldest beneficiary’s ageBeneficiary takes distributions over his or her lifetime, based upon current age
Beneficiary withdraws entire balance by the end of 5th year following year of account holder’s death.

Pitfalls to Roth IRA inheritance

There are a few potential issues that Roth IRA beneficiaries must be aware of so they can avoid a painful tax penalty.

The first is the penalty facing any beneficiary who takes less than the RMD. If you take less than the amount equal to the Roth IRA balance divided by your life expectancy, then you will owe the IRS 50% of the amount that should have been withdrawn.

Another issue facing Roth IRA heirs is what happens if the account does not meet the five-year rule. Until you reach the fifth year from when the Roth IRA was opened, any distributions you take will be subject to regular income tax. That’s because you, as beneficiary, are being treated as if you are the account owner who is taking distributions prior to the end of the five-year period. However, you are not subject to the 10% penalty Roth IRA account holders face when they take distributions before five years have passed.

You can easily avoid this tax burden by waiting to take distributions until the Roth IRA meets the five-year rule.

Bottom line

Although Roth IRAs have no RMDs for primary account holders, beneficiaries should take their time in understanding the rules governing inherited Roth IRAs. That way they can make the best financial decision with their inheritance and stay on the IRS’s good side.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Emily Guy Birken
Emily Guy Birken |

Emily Guy Birken is a writer at MagnifyMoney. You can email Emily here

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Investing

Understanding the Pros and Cons of the Reverse Rollover

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Rolling over a 401(k) into an IRA is a common process that can help a saver maintain control of their retirement investments even when they part company with the employer providing their 401(k) plan.

Fewer people are familiar with the so-called “reverse rollover,” wherein an IRA account holder rolls over those funds into an employer-sponsored 401(k). Though less common, there are a number of reasons why a saver might want to consider it — as well as several drawbacks. Here’s what you need to know about these accounts and how reverse rollovers between them can work.

Differences between an IRA and a 401(k)

While both of these accounts offer tax-deferral benefits, there are a few important differences to be aware of when choosing either type of account. In addition, it’s important to remember that you may open and contribute to each type of account at the same time, so a rollover may be unnecessary if you are eligible for both account types.

The important differences to remember between IRAs and 401(k) accounts are their contribution limits and income limits:

  • Contribution limits: For 2019, the IRA contribution limit is $6,000 ($7,000 for those over age 50), and the 401(k) limit is $19,000 ($25,000 if over age 50). You can contribute to both a 401(k) and an IRA at the same time, so if you are able to do both, a rollover may not be necessary to increase your total contribution limit.
  • Income limits: IRAs also have a lower compensation limit for receiving the tax-deferral. Savers eligible for an employer-sponsored retirement plan receive a full tax deduction for IRA contributions if their income is less than $64,000 ($103,000 for married couples filing jointly). For 401(k) accounts, the income limit is $280,000 before savers lose the tax-deferral.

Though you can hold both accounts at the same time, you may still be interested in a reverse rollover. There are some important benefits and drawbacks that you should be aware of.

Reasons to choose a reverse rollover

  • Easier Roth conversion: The Roth IRA is funded with already-taxed dollars, which means it grows tax-free and you can take tax-free distributions in retirement. However, if you are single and make more than $137,000 or married and make more than $203,000, you cannot contribute to a Roth IRA, but you can convert a traditional IRA into a Roth. You’re required to pay taxes on any money in the account that has not already been taxed. So if you have a mix of pre- and post-tax money in your IRA, you can move the pre-tax money into a 401k before doing the Roth conversion. That will leave any post-tax contributions in the IRA available to convert into a Roth IRA without paying any more taxes at the time of conversion.
  • Bankruptcy protection: 401(k) accounts are qualified accounts under the Employee Retirement Income Security Act (ERISA) and not considered to be part of your bankruptcy estate. Until 2005, IRAs had no such protection, but the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCA) exempted a portion of IRAs from bankruptcy estates. The IRA amount exempted is currently $1,283,025.
  • Earlier access to funds: Both 401(k) accounts and IRAs have stiff tax penalties for accessing your funds prior to reaching age 59 and a half. However, a 401(k) account holder who leaves their job anytime during or after the year they turn 55 may take distributions from the 401(k) without penalty.
  • Postponed distributions: 401(k) accounts may help postpone required minimum distributions (RMDs), which are the mandated amount you must withdraw from tax-deferred retirement accounts at age 70 and a half. There is no getting around IRA RMDs, but if you are still working at age 70 and a half, you may postpone distributions from your 401(k) until you retire.
  • 401(k) loan options: In a bad financial crunch, you may be able to take a loan from your 401(k) without paying taxes on the withdrawal. You’re required to repay the loan with interest (to yourself) within five years, and if you separate from your employer before you have paid back the loan, it’s considered a distribution, triggering taxes and penalties.

Reverse rollover downsides

  • Fewer investment options: 401(k) plans offer fewer investment options than IRAs, so anyone who wants to hand-pick their investments would be happier sticking with an IRA.
  • Access for higher education and home purchase: While both IRAs and 401(k) accounts allow you to take early, taxable distributions without penalty because of hardship such as disability, medical, or funeral expenses, only IRAs allow such an early, penalty-free (but taxable) distribution for higher education or a first-time home purchase.
  • Indirect rollovers can cost you: With an indirect rollover, your IRA cuts a check for you to deposit into your 401(k). However, your IRA administrator is required to withhold 20% of your distribution for federal taxes. For instance, if you’re rolling over $25,000, you will receive a check for $20,000 and the remaining $5,000 will be sent to the IRS. But you will still be required to deposit the full $25,000 in your 401(k) or face the tax penalty.

How to roll over an IRA into a 401(k)

Start by making sure that your 401(k) plan will accept a rollover from your IRA, since not all plans do. Get your 401(k) set up before you initiate the rollover because you only have 60 days to get the money from one account to the other without a penalty.

Ask your 401(k) plan administrator how to do a direct transfer, where your IRA administrator makes the payment to your 401(k) and you face no tax or penalty. If the money comes to you first in an indirect rollover, 20% of the amount is withheld and you must make up the difference.

Bottom line

Rolling over an IRA into a 401(k) can provide you with a higher contribution and income limit for tax-deferrals, more control over when you take your distributions, an opportunity for an easier Roth conversion, and more financial protection if you face serious money troubles. But it can also limit your investment choices, make it harder to pay for education or a home, and can be costly in the case of an indirect rollover. Savers interested in a rollover IRA to 401(k) must understand all of the ramifications before they commit.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Emily Guy Birken
Emily Guy Birken |

Emily Guy Birken is a writer at MagnifyMoney. You can email Emily here

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Investing

What’s the Best Age to Open a Roth IRA?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

The Roth IRA is often touted as a great savings vehicle for younger investors. Since the money you put into a Roth IRA has already been taxed, young investors can put money aside while their income (and tax burden) is lower, then reap the benefits in the form of tax-free withdrawals in retirement.

But there is no age limit on Roth IRAs making good financial sense. In fact, since workers are allowed to contribute to a Roth IRA past the age of 70 and a half as long as they are still earning income, a Roth IRA is the only tax-advantaged investment vehicle available to those in their 70s and beyond.

If you’re wondering if you are too old or young to take advantage of a Roth IRA, remember that any age can be just right for investing in one.

How old do you have to be to open a Roth IRA?

As a tax-advantaged investment vehicle, Roth IRAs (like their traditional counterparts) have some strict eligibility rules. But unlike traditional IRAs, there are fewer age-related eligibility rules for Roth IRAs.

For instance, with traditional IRAs, investors over the age of 70 and a half are prohibited from making contributions, whether or not they are still earning income. In addition, traditional IRA account holders must begin taking required minimum distributions (RMDs) as of age 70 and a half, while Roth IRAs have no such distribution requirement and you may leave money in a Roth account for as long as you live.

The only age-related rule that both Roth and traditional IRAs share is the age at which account holders may begin making withdrawals without facing a penalty. In both cases, that age is 59 and a half. Until you reach that magic number, both Roth and traditional IRA distributions will be subject to the 10% tax penalty. In addition, you cannot take a penalty-free distribution from your Roth IRA earnings if it has been less than five years since you opened it.

No matter your age, as long as you have earned income, you can open a Roth IRA. However, your total modified adjusted gross income (MAGI) will help determine how much you can set aside in your Roth IRA. In 2019, the contribution limit for both traditional and Roth IRAs is $6,000, rising to $7,000 for filers who are age 50 or over. It’s important to remember that this contribution limit is applied to all of your IRA accounts if you have more than one. This means your total contributions to all of your traditional and Roth IRAs cannot be more than $6,000.

Taxpayers who are married filing jointly can contribute up to the maximum amount to their Roth or traditional IRA if their MAGI is below $193,000. A married couple can contribute a reduced amount if their MAGI falls between $193,000 and $203,000, and couples earning more than $203,000 may not contribute to a Roth IRA in 2019. Single filers are eligible for a full contribution up to a MAGI of $122,000, a reduced contribution between $122,000 and $137,000, and may not make a contribution with a MAGI above $137,000.

Basically, as long as you make at least $6,000 and make no more than the MAGI limits for your filing status, you can contribute the full amount to your Roth IRA, no matter your age.

Roth IRA benefits for young contributors

  • Pay taxes at a lower level: Provided you wait until age 59 and a half (and own the Roth IRA for at least 5 years before making a distribution), you can access the money in your Roth IRA tax-free. This means a younger contributor could pay a lower amount in taxes on that money, since their tax bracket is likely to be lower now than it will be later in their career or even in retirement. In addition, since it’s impossible to know exactly what kind of tax burden you will be facing in retirement, having money in a tax-free vehicle provides you with a hedge against future taxes.
  • Compound interest: In addition to your distributions being tax-free in retirement, your contributions grow tax-free, which means you get to enjoy all of the gains from your investment in retirement instead of having to see some of those gains lost to taxes. The other benefit of compound interest is the fact that it can make even modest early contributions grow to something quite robust.
  • Future income hedge: If you expect to eventually make too much money to contribute to an IRA, investing in a Roth IRA early in your career can guarantee you the benefit of compound interest and tax-free growth even after you stop being eligible to contribute.
  • Access your contributions tax-free: While you would have to pay taxes and penalties on withdrawals from your gains in a Roth IRA, the amount that you contributed can be withdrawn tax- and penalty-free, because that money has already been taxed. This makes the Roth IRA a much more flexible account than other tax-advantaged retirement accounts.

Roth IRA benefits for older contributors

  • Diversify your retirement income Social Security benefits, pension benefits and withdrawals from traditional IRAs and 401(k)s are all subject to taxation in retirement. In fact, the amount of taxes you will owe on your Social Security benefits depends in part on how much income you have from your pension, traditional IRA or 401(k). By having a Roth IRA set up so that you have a source of tax-free income in retirement, you can give yourself a little more control over your tax burden.
  • Estate planning: Since you are not required to take distributions from your Roth IRA as of age 70 and a half, you can use your Roth IRA as a method of passing money along to your heirs tax-free. By naming your heir as a beneficiary of your Roth account, the money could pass to your heir without being subject to estate taxes. Do note that inherited IRAs are subject to required minimum distributions, even in the case of Roth IRAs.
  • Compound interest is still your friend: Because you are not required to take required minimum distributions as of age 70 and a half, older Roth IRA contributors can get the benefit of compound interest in ways that they could not with a traditional IRA. Even if you do not open a Roth IRA until after age 40, 50, or later, you can leave the money in the account for as long as you like, potentially giving it decades to grow before you access it. A traditional IRA puts a cap on that potential for growth by forcing you to take RMDs as of age 70 and a half.
  • Backdoor Roth conversions can open up your eligibility: Even if you make more than the income limit for contributions, it is possible to convert your traditional IRA into a Roth account using what’s called a “backdoor Roth conversion.” Before you convert your entire traditional IRA, don’t forget that you’ll owe taxes on any pre-tax money and growth that gets transferred to your Roth IRA.
  • Catch-up contribution limits: Investors over the age of 50 may contribute a full $1,000 more per year than those under the half-century mark. This means an older Roth IRA contributor can set aside $7,000 in 2019.

The bottom line

There’s no one right time to open up a Roth IRA. Whether you are a fresh-faced recent college grad or the grizzled veteran at your workplace, you can benefit from a Roth IRA. Just make sure you understand the potential advantages and disadvantages of setting aside already-taxed money into a Roth IRA.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Emily Guy Birken
Emily Guy Birken |

Emily Guy Birken is a writer at MagnifyMoney. You can email Emily here

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