Can an Inherited IRA Be Converted?

Can an inherited IRA be converted

If you inherit an IRA, there are a variety of distribution options available to you when taking ownership. It is crucial that you understand all applicable tax rules prior to making any decisions regarding distributions from it.

Based on your situation, it may be wise to allow your inherited assets to continue growing before taking distributions, as this can help avoid paying unnecessary taxes while enjoying potential tax-free growth.

Non-spouse beneficiaries

Non-spouse beneficiaries may face more administrative hurdles when inheriting an IRA than spouse beneficiaries, as they cannot simply roll their portion into an existing account but instead must create a new, inherited IRA in which to transfer the inherited assets; whether or not that account allows additional contributions will depend on how the original owner created his or her account.

Similar to spouse beneficiaries, non-spouse beneficiaries should review all of their account beneficiary designations periodically in order to prevent unintended results when it’s time to take RMDs.

Prior to 2022, many tax experts and financial planners advised non-spouse beneficiaries of an inherited IRA account using the five-year rule to disburse it over an extended period of time and thus potentially lower tax burden in the long term.

Rolling into an existing IRA

An Individual Retirement Account, or IRA, provides tax-deferred growth on investment earnings. Funding may occur either before or after taxes depending on its initial owner and any applicable regulations.

After an IRA owner passes, their assets are distributed among their beneficiaries. A spouse can choose whether or not to transfer his or her share into their existing IRA; other beneficiaries such as children, charities, trusts or estates may face more complex decisions regarding what happens next.

Bequest recipients and the age at death of the original IRA owner determines its fate; non-spouse beneficiaries can take advantage of the 10-year rule to withdraw inherited money in increments over 10 years. When making these decisions, it’s wise to consult a financial professional for guidance – the right strategy could help beneficiaries preserve assets longer while minimizing taxes.

Converting to a Roth IRA

Inheriting an IRA can be complicated. Before making any changes to your inheritance, it’s wise to consult a tax professional first. Non-spouse beneficiaries cannot contribute additional funds into an inherited IRA but may move it into a Roth IRA which offers tax free withdrawals provided it’s been open for five years and meets other criteria; prior to 2020 beneficiaries could extend traditional IRA withdrawals over their life expectancy to reduce tax bills.

Rules surrounding inheriting an IRA can be complex and vary depending on its type and age of original account owner. A financial or tax professional can help you assess which options would work best in your situation. In general, RMDs from an IRA should start being taken at the start of each year following death to avoid steep tax penalties.

Stretching withdrawals

Beneficiaries have the option to either divide up their taxable distributions according to law over their life expectancy, or withdraw it all within 10 years after an account owner dies and make lump-sum withdrawals without incurring the 10% penalty fee if they’re under age 59 1/2.

Stretched distributions are an appealing strategy for beneficiaries who will need their inheritance income during their peak earning years and/or want to reduce taxes paid, yet recent IRS guidance put an end to it for non-spouse heirs of traditional IRAs.

If you inherit an IRA and do not plan to use its funds immediately, consider rolling it over into an IRA in your name and treating it like your own asset. That way, tax-deferred growth of assets will continue. Consult a financial professional in order to explore all available options – as IRA rules can be complex, it’s wise to consult an expert who understands them before proceeding with anything yourself.

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