Estate taxes, Roth IRAs and beneficiaries / What are the rules for taking distributions from inherited Roths?

Karin Price Mueller/The Star-Ledger  writes: Question. My husband and I have a trust set up to be funded at the death of the first spouse and disbursed equally to our two children at the death of the second spouse. The purpose of the trust is to keep $675,000 — the New Jersey estate tax exemption — out of the second spouse’s estate. Our question is what to do about Roth IRAs. The primary beneficiary is the spouse. Should the secondary beneficiary be the trust, or the two children? What are the rules for taking distributions from inherited Roths?

Answer: The Brain hopes you have many years to go.

And we’re also glad you’re asking these questions now, before it’s too late to make any changes to your plan.

A Roth IRA must be in existence for at least five years before earnings can be withdrawn tax-free, said Shirley Whitenack, an estate planning attorney with Schenck, Price, Smith & King in Florham Park.

She said there are two important rules for distributions of inherited Roth IRAs.

"The beneficiary of a Roth IRA must receive the entire distribution by Dec. 31 of the fifth year following the year of the owner’s death or the beneficiary must receive the entire distribution over his or her life or over a period not extending beyond the life of the beneficiary," she said.

If the beneficiary chooses the first option, then distribution can be delayed if necessary until the fifth year after the year the IRA was established to avoid paying a tax on the distribution of the earnings, she said. Alternatively, the beneficiary can withdraw all amounts other than earnings before that time without paying tax.

If the second option is chosen, Whitenack said, then the beneficiary may be required to receive some distributions before the Roth IRA has existed for five years.

"That may not result in any tax, however, because the distributions will not be deemed as coming from earnings until all of the contributions are withdrawn," she said. "These rules do not apply to Roth IRAs inherited by a spouse if the spouse elects to treat it has his or her own IRA."

To the trust: yes, the trust can be named as an IRA beneficiary. This may make sense when the beneficiaries are minors, have special needs, are spendthrifts or are children of a first marriage, she said.

"A trust beneficiary of an IRA should be structured to qualify as a ‘see through trust’ so that its individual beneficiaries will be treated as ‘designated beneficiaries,’" Whitenack said.

She said such trusts must satisfy four requirements: 1) the trust must be a valid trust under state law, 2) the trust must be irrevocable or become irrevocable upon the death of the account owner, 3) the beneficiaries must be "identifiable from the trust instrument," and 4) certain documentation must be provided to the plan administrator.

She said the minimum required distributions are based on either the life expectancy of the oldest beneficiary of the trust if the trust is a designated beneficiary, or the five-year rule if the trust beneficiary is not a "designated beneficiary."

"Since distributions from a Roth IRA are generally tax free to the beneficiary, which is not the case with a traditional IRA, the acceleration of minimum required distributions is not as significant as it would be with a traditional IRA," she said.

You should consult with an estate planning attorney to see if your trust qualifies as a "see through trust" and whether it makes sense to name the trust as a beneficiary of the Roth IRAs.