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Say my wife inherits my IRA before the 5 years have passed, and continues it as a Roth. After the 5 years, she’d have the option of not taking any RMDs. Would our kids (the IRA beneficiaries at her death), get tax-exempt withdrawal benefit from the IRA?


First, an explanation of the five-year rule that you allude to: The key difference between a Roth IRA and the regular variety is that contributions to a Roth are made with money that has already been taxed and so there is no further liability when the original money is distributed. The investment returns – income and capital gains – that accrue on the assets in a Roth have not been taxed, however, and so the portion of a distribution that comes from those investment gains is subject to income tax, but only if the distribution is taken less than five years after Jan. 1 of the year in which the account is opened. So if you opened your Roth IRA on June 15, 2007, you can cash out free and clear after Jan. 1, 2012.
As with other assets, a Roth IRA passes tax free to a spouse upon the owner’s death, but it’s generally better to keep the IRA in the original owner’s name because it eliminates the 10 percent early-withdrawal penalty otherwise assessed if a taxable distribution is taken by the surviving spouse before age 59 and a half. And there’s another wrinkle – another five-year rule for Roth IRAs – that’s relevant to your question about your children’s inheritance. Any beneficiary other than a spouse must take a distribution of Roth IRA assets, either all at once or evenly spread over the beneficiary’s expected lifetime, within five years of the previous owner’s death.
Put all of this together and it means that if you die there will be a window beginning five years after you opened the Roth IRA and ending five years after your death within which your wife and, if she were to die, too, your children could cash out the IRA or set up lifetime payments with no tax liability. It’s complicated, as you can see. A good solution for you is to hire a knowledgeable lawyer or accountant. An even better solution is regular exercise and healthy food for you and your wife so that you won’t have to face this dilemma for a long time.


-Conrad de Aenlle