Can an Inherited IRA Be Converted?
When inheriting an IRA, distribution rules can be complex. There are two options available to you for making necessary distributions: either rolling it over into your own IRA account and spreading RMDs over both of your lifetimes or the deceased person’s. But ultimately you must clear out their account within 10 years or empty out an inherited one entirely.
Taxes
If you inherit an IRA, its tax regulations differ significantly from those that apply to your own retirement account. Hiring a financial advisor may help make sense of this complex matter and address any questions or address concerns that arise regarding it. SmartAsset’s free tool connects you with up to three vetted advisors who serve your area; interview each at no cost until deciding which is the right match for you.
Within 60 days of inheriting an IRA, it must be transferred into your own IRA account, with withdrawals treated as taxable income. Furthermore, you must comply with required minimum distribution (RMD) rules that vary based on beneficiary type and date of death of the original owner.
Before this rule change, non-spouse beneficiaries could “stretch out” their RMDs over decades if the deceased was older than 59 1/2. Now this option is only open to surviving spouses and “eligible designated beneficiaries”, such as children, disabled adults or those suffering chronic illness.
Required minimum distributions
Like retirees, heirs of IRA assets must take periodic withdrawals called required minimum distributions (RMDs), which depend on either their life expectancy or that of the deceased account owner. For an inherited IRA account owner’s beneficiaries these withdrawals will vary based on life expectancies of either beneficiary.
Spousal beneficiaries have several options for taking RMDs; one being delaying them until their death. Nonspousal beneficiaries, on the other hand, have more freedom. A stretch IRA might be appropriate or they could withdraw assets over their life expectancies as long as they are minor children or chronically ill or disabled and not more than 10 years younger than the original account owner.
The SECURE Act introduced new IRA distribution rules in 2020, mandating that nonspouse beneficiaries typically empty their inherited accounts within 10 years unless they qualify for an exception. While the IRS is yet to finalize regulations regarding missed withdrawals, penalties could be steep; beneficiaries should plan accordingly.
Roth IRAs
When inheriting a Roth IRA, there are no income tax repercussions for its recipient. He or she can keep the money in the account and spread withdrawals out over an extended period – as long as full payments aren’t taken by December 31 of the year following the original owner’s death.
No matter if an inherited IRA was opened with pre-tax dollars or after-tax dollars, IRS rules are consistent: beneficiaries should follow the same RMD schedule as its former owner and use the single life expectancy factor to calculate annual RMDs.
An alternative way for an heir to minimize taxes on inheritance assets may be transferring the assets directly into his or her IRA by taking control of it through what’s known as a “spousal transfer”, also called “assuming an IRA”. This method is known as “spousal transfer or “assuming an IRA”, and treated by the IRS as though its new owner had always controlled it – an effective strategy for doing just that!
Rollovers
If a deceased leaves you their IRA, you can roll it over into an account in your own name and treat it as your own – provided you abide by contribution limits for both accounts and tax law compliance (for instance naming it “IRA FBO [deceased Owner], beneficiary”). If you’re married to the deceased owner and assume ownership, RMDs can also be stretched over either your lifetime or over their life expectancy, whichever comes first.
Your first decision when accessing funds from an inherited IRA should be whether to take a lump-sum distribution and access them instantly, though doing so could increase your taxable income and potentially push you into higher tax brackets. Also, by doing this you could miss out on years of tax-deferred growth potential that would otherwise have occurred over time. Consulting a financial advisor could help determine the optimal strategy for you as rules surrounding inherited IRAs are complex and may have unexpected ramifications.
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