Can You Convert an Inherited IRA?

Can you convert an inherited IRA

If you inherit an IRA, it’s essential that you understand all of its options as soon as possible to avoid making costly errors that result in additional taxes being due.

Nonspouse beneficiaries who inherit an IRA can use their life expectancy to determine Required Minimum Distributions and may choose to spread withdrawals over 10 years.2

However, there are two exceptions.

How to Convert an Inherited IRA

Tax rules surrounding inherited retirement accounts can be complex. Consulting with a financial expert is essential in understanding all your options and making the appropriate choice for your circumstances.

Beneficiary IRAs, also known as Inherited IRAs, may be established by anyone designated to inherit an IRA or workplace retirement account upon its original owner’s death. Beneficiaries can transfer funds between accounts within their own IRA accounts or open new inherited IRAs; they must typically empty out the balance within 10 years after this event has taken place.

An inherited IRA can take any form imaginable — traditional and Roth IRAs, SEP/SIMPLE IRAs and 401(k) plans all qualify – from traditional to Roth, SEP/SIMPLE to SIMPLE accounts as well as 401(k). Income tax treatment remains identical regardless of whether it was created using pre-tax dollars (traditional IRA) or post-tax dollars (Roth IRA). Beneficiaries must take mandatory minimum distributions starting the year following their account owner’s passing.

Roth Conversions

Roth conversion involves moving money from an existing nondeductible retirement account into a Roth one, using financial institutions as middlemen in this process. You will use the IRS pro-rata rule to determine how much of your IRA funds that have yet been taxed will become subject to ordinary income taxes, in order to calculate your tax bill; experts advise stretching this out over several years so as to lessen any immediate tax bill impact.

Roth conversion may make sense for you if you anticipate being in a higher tax bracket after retiring or rising tax rates in general, though you should carefully weigh its costs against benefits before making your decision. Furthermore, time horizon is also an important factor – converted funds must remain within a Roth for five years to avoid paying a 10% withdrawal penalty when withdrawing them.

Traditional Conversions

As a beneficiary of your spouse, if they pass assets on to you, it’s possible to roll them over into an IRA under your name and treat them as though they’d always been yours, providing several advantages: not having to pay the 10% early withdrawal penalty tax before age 59 1/2; tax-free growth on assets; as well as receiving a step-up in cost basis that may lower your federal income tax bill, according to Kane.

Nonspouse beneficiaries who inherit assets cannot transfer them into their own IRAs and must begin withdrawing them annually by the end of the 10th year following the death of the original account owner, known as their Required Beginning Date or RBD.

RBD rules vary based on the type of IRA held and whether or not its account holder was over 72 when they died, so consult your financial advisor in order to understand all available options and any conversions from taxable accounts into an IRA could have tax ramifications.

Cashing Out

Tax regulations surrounding inherited IRAs can be complex and vary based on the account owner’s relationship to their beneficiary and whether or not it was an IRA or 401(k), yet all beneficiaries must follow similar withdrawal rules when withdrawing funds from an inherited account.

Non-spouse beneficiaries typically must empty their IRA within 10 years or face heavy penalties; however, exceptions exist for minor children, those living with chronic illness or disability and those not more than 10 years younger than the original account owner.

Recipient spouses of an inherited IRA can elect to treat it as their own and bypass the 10-year rule if they act within nine months of its original owner’s death; this option could rob them of up to 10 years of tax-free growth in their account, however. It’s wiser to speak with an investment professional or tax expert prior to making such a decision as they can outline all possible solutions and consequences of each decision.


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