Can an Inherited IRA Be Converted?

Can an inherited IRA be converted

An inherited IRA can be an intimidating financial asset to manage. Finding the appropriate advisor can help you understand all your options and make informed decisions for your situation. SmartAsset’s free tool connects you with pre-screened advisors in your area; interview them all at no cost before choosing which is the right match for your situation.

Taxes

Good news is that an inherited IRA allows your funds to continue growing until age 72 – giving your account time and space to flourish while also deferring income tax payments until then.

However, one important rule must be observed: you must close the account within 10 years unless it relates to a spouse of the original owner or has another special circumstance such as chronic illness or disability.

Converting an IRA to a Roth isn’t without tax implications, though. A substantial conversion could land you in a higher tax bracket and impact Medicare and Social Security payments negatively. But if retirement is imminent and your tax bracket should begin dropping, Roth conversion might make sense for you; just be sure to discuss the decision with an experienced financial professional for guidance before making this choice.

Required minimum distributions

Beneficiaries of an IRA should understand the rules that apply when inheriting an account. The first step should be identifying whether the original owner took his or her required minimum distribution (RMD) in their year of death – if not, then it falls upon their beneficiary to do so and pay a 50 percent penalty on any undistributed assets if this deadline passes without action being taken.

If a beneficiary decides to roll their inherited IRA into their own account, they must do so within 60 days or face tax consequences. If they opt for lump sum distribution instead, if under 59 1/2, income taxes must also be withheld from this amount.

However, they can avoid tax repercussions by choosing to keep their inherited IRA intact and take their RMDs in periodic withdrawals instead of early withdrawal penalties of 10%. By spreading out their distributions over their lifetime without worrying about penalties for early withdrawal, their distributions will stretch out over a longer period.

Rollover options

When inheriting an IRA from someone other than your spouse, once the account reaches its Required Beginning Date (RBD), typically every year, after reaching that RBD date. This rule applies to all types of IRAs – traditional, SEP and SIMPLE accounts alike. If you are younger than 59 1/2, however, part of your distributions will also incur taxes as they come due.

However, if you are the spouse of an account owner who has died, an inherited IRA may be transferred into your own IRA or employer retirement plan to avoid incurring the 10% early withdrawal penalty and keep tax-deferred until withdrawal time. Before taking this route though, be sure to consult a tax advisor as rules surrounding IRA inheritance can be complex – working with one will ensure compliance and no penalties.

Distribution options

IRS.gov offers comprehensive rules on inherited IRAs, yet it may be challenging to decide how best to take distributions when the time comes. Therefore it is advisable to consult a financial advisor in order to explore all your options.

Typically, inheriting an IRA means rolling its assets over into your own IRA; however, another alternative might be Roth conversion which allows you to retain these tax-deferred assets until needed.

Other options for inheritors may include taking either a lump sum distribution or declining their inheritance altogether. The required minimum distribution (RMD) rules vary based on when and how long after an original account owner dies you become beneficiary or Eligible Designated Beneficiary; some beneficiaries choose the stretch option which allows them to withdraw RMDs over 10 years without incurring income tax; however, this strategy could result in significant income taxes due to long withdrawal schedules for larger accounts.


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