Can an Inherited IRA Be Converted?
After death, beneficiaries inheriting assets held within an IRA must abide by the same withdrawal regulations and mandatory minimum distributions as was set out for their account owner.
Non-spouse beneficiaries have two options for handling an inherited IRA: they may roll it over into their own IRA, though this could increase taxes; or they can convert the inherited account into Roth assets via Roth conversion.
Traditional IRA
As inheritance IRAs often represent large portions of family wealth, it’s crucial that beneficiary information filed with their IRA custodian remains accurate. Any discrepancies could create future issues.
Before 2020, non-spouse beneficiaries could minimize taxes by deferring withdrawals until their life expectancies or those of the deceased account owner expired. But changes to the law and new guidance from the IRS have rendered that strategy ineffective for non-spouse beneficiaries of traditional IRAs.
An inherited IRA may be distributed tax-free for qualified expenses such as purchasing your first home; adoption or foster care fees; medical costs not covered by health insurance; some disaster costs and retirement income, or otherwise subject to the 10% early withdrawal penalty. Otherwise, its distribution would incur the 10% early withdrawal penalty and should also be considered retirement income unless distributed directly into an inherited IRA of either spouse’s surviving account; distributed directly or even split among contingent beneficiaries such as children/grandchildren/other relatives/charity etc). or trusts
Roth IRA
Roth IRAs are individual retirement accounts that offer after-tax contributions and investment earnings to grow tax free without being subject to Required Minimum Distributions at age 70 1/2, unlike traditional IRAs which do.
Before you make the leap to Roth IRA conversion, there are several key considerations you should keep in mind. First and foremost is that any after-tax IRA balances rolled over into one must wait five years in order to withdraw them without incurring a 10% early withdrawal penalty.
Considerations must also be given to how converting to Roth can increase your taxable income, which may affect marketplace healthcare subsidies or Medicare premiums. Furthermore, future tax brackets or rates cannot always be predicted; ultimately it’s up to each individual to decide if Roth IRA benefits make sense for themselves.
Rollover
If you are the spouse of an IRA owner or former employer-sponsored retirement plan participant, you have 60 days to transfer their assets into an IRA of your own and treat it like it had always been your own account. Doing this allows you to avoid required minimum distributions (RMDs) until age 73 without incurring income taxes at distribution; but if all funds are deposited within 60 days into an IRA without income taxes withheld for distribution owing, no withholding taxes apply and therefore no taxes withheld are due on.
Spouse beneficiaries have two options for taking control of an inherited account after its holder passes: either through an indirect rollover, or treating the account as its own Roth IRA and deferring RMDs until required to take them; non-spouse beneficiaries must either start taking withdrawals immediately or follow the 10-year rule, which calls for it to be empty by December 31 of the year following its holder’s death.
If you are a non-spouse beneficiary looking to extend their withdrawals, work with a tax planning professional on devising a withdrawal strategy tailored specifically for you. Remember, however, that doing this means losing out on years of tax-deferred growth within an IRA balance.
Withdrawal
Inheriting an IRA requires additional paperwork for non-spouse beneficiaries, but income tax rules remain unchanged. Assets must be moved into a new account that conforms to tax law (i.e. “Owner’s name, deceased, IRA FBO [your name], beneficiary”).
Heirs of an inherited account must empty it within 10 years, except in certain limited instances such as being spouses or children of the original account owner, chronically disabled individuals, or those not more than 10 years younger (so-called “stretch options).
Heirs who withdraw assets quickly may incur a substantial income tax bill. Families can avoid this by consulting with a financial professional to devise the optimal withdrawal strategy for them and their particular situation. Furthermore, all beneficiaries listed on an IRA should remain current and accurate so that all those entitled receive their share.
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