Is It Better to Inherit a Roth or Traditional IRA?

Receiving an Individual Retirement Account (IRA) as an inheritance involves navigating a distinct set of financial rules and tax consequences. The type of IRA you inherit—whether it is a Roth or a Traditional account—plays a large part in shaping your financial responsibilities. Understanding the fundamental differences between these two types of retirement accounts is the first step. A Traditional IRA is funded with pre-tax dollars, meaning taxes have been deferred, while a Roth IRA is funded with after-tax dollars. This distinction creates significantly different outcomes when it is time to withdraw the inherited funds, and your relationship to the deceased will further define the path you must follow.

Tax Treatment of Inherited IRA Withdrawals

The primary difference between inheriting a Roth IRA and a Traditional IRA lies in how withdrawals are taxed. For a beneficiary of a Roth IRA, qualified distributions are received free of federal income tax, meaning the money does not add to your taxable income. For a distribution to be qualified, the Roth IRA must have been opened for at least five years before the withdrawal. This five-year clock starts when the original owner first contributed to any Roth IRA.

If you inherit a Roth IRA that is less than five years old, the contributions can still be withdrawn tax-free. However, any earnings withdrawn from the account during this initial five-year period may be subject to income tax. Once the five-year holding period is met, all subsequent withdrawals, including investment earnings, become entirely tax-free.

In contrast, distributions from an inherited Traditional IRA are taxable as ordinary income to the beneficiary. The original account holder received a tax deduction on their contributions, and the investments grew tax-deferred. As the beneficiary, you are responsible for paying the income tax that was postponed. The amount you withdraw is added to your other income for the year and taxed at your personal marginal tax rate.

For instance, a beneficiary in the 35% federal tax bracket who withdraws $50,000 from an inherited Traditional IRA would owe $17,500 in federal income tax. A beneficiary in the 12% tax bracket making the same withdrawal would owe only $6,000. This shows how your own income level directly affects the net value of a Traditional IRA inheritance.

Required Withdrawal Rules for Beneficiaries

Beneficiaries must adhere to specific timelines for withdrawing assets from an inherited IRA. The SECURE Act of 2019 established the “10-year rule” as the requirement for most non-spouse beneficiaries. This rule mandates that the entire balance of the inherited IRA must be withdrawn by the end of the tenth year following the year of the original owner’s death.

Withdrawal requirements during the 10-year period depend on whether the original account owner had started taking their own Required Minimum Distributions (RMDs). If the owner had already begun taking RMDs, the beneficiary must also take annual distributions in years one through nine, with the remainder withdrawn in year ten. If the owner passed away before their RMDs began, the beneficiary can wait until the tenth year to withdraw the entire balance.

The law provides an exception for certain individuals known as Eligible Designated Beneficiaries (EDBs), who are not subject to the 10-year rule. This category includes:

• The surviving spouse of the account owner
• Minor children of the owner
• Disabled or chronically ill individuals
• Beneficiaries who are not more than 10 years younger than the decedent

EDBs have the option to take distributions from the inherited IRA over their own life expectancy, a strategy often referred to as a “stretch IRA.” This allows the funds to remain in the tax-advantaged account for a longer period. For minor children who qualify as EDBs, they can use the life expectancy method until they reach the age of 21, at which point the 10-year rule is triggered.

Unique Options for Spousal Beneficiaries

A surviving spouse who inherits an IRA has unique and flexible options not available to other beneficiaries. As a special type of Eligible Designated Beneficiary, a spouse can choose a path that best aligns with their financial and retirement planning needs.

One primary option is for the surviving spouse to treat the inherited IRA as their own by rolling the assets into their own new or existing IRA. The spouse becomes the new owner of the account, and the funds are subject to standard IRA rules based on the surviving spouse’s age. This means Required Minimum Distributions (RMDs) will be calculated based on their own life expectancy and will not be required until they reach the age for RMDs.

Alternatively, a spouse can choose to remain a beneficiary of the inherited IRA, titling it as an inherited account. This decision can be strategic. If the deceased spouse was younger, the surviving spouse can delay taking any RMDs from an inherited Traditional IRA until the deceased would have reached RMD age. For an inherited Roth IRA, remaining a beneficiary means no RMDs are required at all during the surviving spouse’s lifetime, allowing the funds to grow tax-free.

A Framework for Your Decision

Deciding which type of inherited IRA is “better” depends on your personal circumstances. To make an informed choice, you must analyze your situation based on your beneficiary status, financial standing, and long-term goals.

First, identify your beneficiary status. A spouse has the most flexibility, while an EDB can stretch distributions over their lifetime. A standard beneficiary must empty the account within a decade, which can accelerate tax consequences for a Traditional IRA.

Next, evaluate your current and projected financial situation. If you are in a high income tax bracket, inheriting a tax-free Roth IRA is advantageous. If you are in a lower tax bracket, the tax impact of withdrawals from a Traditional IRA may be more manageable.

Consider your immediate need for the funds versus your desire for long-term growth. Finally, align the inheritance with your long-term financial objectives, such as preserving capital for retirement or funding a specific goal. Answering these questions will help clarify whether the tax-free benefit of a Roth or the tax-deferred growth of a Traditional IRA better suits your needs.