Inherited Roth IRA: Why the Five-Year Rule Can Still Make Earnings Taxable for Heirs

Quick Read

• A daughter withdrew the full $240,000 from an inherited Roth IRA too soon, leaving $40,000 in earnings taxable and creating a $9,600 federal tax bill.

• The father’s five-year clock began on January 1, 2023 and does not restart at death, so earnings taken out before January 1, 2028 are taxable to the heir.

• Heirs who are not eligible designated beneficiaries do not face annual required minimum distributions, but they must empty the inherited Roth by December 31 of the 10th year after death.

• At the national average savings rate, $40,000 earns about $150 a year. In one of today’s top high-yield accounts, the same balance can earn $1,200 or more. Compare current rates side by side.

A 51-year-old daughter inherited her father’s Roth IRA after he opened it in 2023 by converting $200,000 from a traditional IRA. When the custodian retitled it as an inherited Roth, the account had grown to $240,000.

She had always understood that Roth withdrawals are tax-free. In the fall, she took out the entire balance to pay down her mortgage. Her CPA later explained that $40,000 of that withdrawal must be reported as taxable income on her 2026 return.

The Roth account itself was legitimate. The timing was not. Her father’s account had not yet satisfied the five-year requirement, and she withdrew the earnings a little more than a year too early.

The Five-Year Roth Clock Continues After Death

The key issue is timing. Section 408A(d)(2)(B) says a distribution is not qualified if it is made during the five-taxable-year period that begins with the first year the owner contributed to a Roth IRA.

Treasury regulation 26 CFR 1.408A-6, A-2 starts that period on January 1 of the year of the owner’s first regular contribution or first conversion. Under A-7(a), the clock is not reset when the owner dies, and the heir simply adds her holding period to the time her father already accumulated. Under A-7(b), the inherited Roth’s clock is separate from her own Roth IRAs, so an older personal Roth account gives no shortcut.

Because the father’s first Roth money went in during 2023, the five-year period runs from January 1, 2023 through December 31, 2027. Any earnings distributed before January 1, 2028 are taxable.

Breaking Down the Tax on a $240,000 Inheritance

Roth distributions follow a specific order. Under A-8, withdrawals come first from regular contributions, then from conversions on a first-in, first-out basis, and only then from earnings. Under A-4, a nonqualified distribution is taxable only to the extent that it exceeds total contributions.

That means the father’s $200,000 conversion came back to her tax-free. The remaining $40,000 of earnings is ordinary income. A nonqualified distribution to a beneficiary is taxed the same way it would have been taxed to the original owner.

She does not owe the 10% early-withdrawal penalty. Section 72(t)(2)(A)(ii) exempts distributions made to a beneficiary after the owner’s death, and that exemption also applies to converted money that is still within its own five-year window.

She files as single, and her salary already places her in the 24% bracket, which IRS tables put between $103,351 and $197,300 of taxable income for single filers. If the full $40,000 is taxed in that bracket, the federal bill comes to $9,600, before any state income tax.

Waiting Until 2028 Would Have Avoided the Tax

She could have withdrawn the full $200,000 of conversion money in 2026 to help with the mortgage and still owed nothing. If she had left the $40,000 in the inherited account until January 2028, those earnings would have come out as a qualified distribution and would have been free of federal tax. The delay alone would have saved her $9,600.

The better strategy may have been to leave the entire account invested. Roth IRA owners are treated as though they died before their required beginning date, so an adult child who is not an eligible designated beneficiary does not have annual required minimum distributions. She has one deadline: Section 401(a)(9)(H)(i) extends the old five-year payout rule to 10 years, and the account must be fully distributed by the end of the 10th calendar year after the year of the owner’s death. If the death occurred in 2026, the deadline would be December 31, 2036.

Before Taking Money From an Inherited Roth

A CPA or estate attorney can verify the relevant dates using your family’s records before any withdrawal is made. The inherited Roth five-year rule is one of several tax provisions that can create six-figure mistakes in retirement accounts, and the rest are covered in a free report.