Can You Convert an Inherited IRA?
If you are the beneficiary of an IRA, there are various options for how you should manage it. One is rolling assets into an IRA of your own – which allows the money to continue growing tax-deferred.
You have several options when withdrawing funds as inheritance, from withdrawing them as a lump sum (though that may push you into higher tax brackets) or disclaiming them altogether (although this should be discussed with an estate planning expert first).
Taxes
Tax considerations with inherited IRAs are of great significance, and generally more stringent rules for them than for own-name accounts. An inherited IRA may require annual distributions (or in certain instances, full distribution within a set number of years) or asset distribution within an allotted timeframe post death of its account holder.
Non-spouse beneficiaries have the option to rollover an inherited IRA into their own account (known as “assuming ownership” of an IRA). This will enable them to follow the same distribution rules that would have applied if they had always owned it.
However, according to IRS requirements, an inherited IRA should be treated as one account when calculating taxes associated with any conversions; thus if you convert an inherited IRA into Roth, all the amount converted will have to pay taxes upon conversion.
Withdrawals
After an IRA owner dies, his or her beneficiaries have many choices regarding how they want to divide up his or her inheritance. Non-spouse beneficiaries typically have less flexibility than spouse beneficiaries when it comes to handling an inheritance; they can either take it all in one lump sum payment or distribute the assets over their lifetimes.
Taken at face value, taking a lump sum can often be the more cost-efficient approach – particularly for heirs with higher tax rates than the deceased IRA owner. But they should still carefully consider its impact on future taxes when making this decision.
Non-spouse beneficiaries may spread withdrawals over their lifetimes, starting required minimum distributions (RMDs) by December 31 of the year after an account holder dies. It is best to consult a financial professional when choosing how best to access an inherited IRA and take full advantage of all potential tax advantages.
Rollovers
If you inherit an IRA, a spousal rollover allows you to transfer it over into your own IRA. This makes the account yours and changes its rules regarding distributions – in particular, annual distributions could then be determined according to your life expectancy instead of that of the deceased account owner.
Alternately, you could let an inherited account follow its own 10-year rule for disbursing funds. In this instance, it would be necessary to take a minimum required distribution upon death and distribute any remaining balance over your lifetime.
Tax implications associated with an inherited IRA can be complex and therefore it can be beneficial to work with an advisor who specializes in them and understands all available options. Take time to carefully consider all your choices prior to making any irrevocable decisions – this way you’ll ensure it achieves what it was meant for. Michael Kitces serves as Head of Planning Strategy at Buckingham Strategic Wealth, offering evidence-based wealth management for near and current retirees.
Conversions
When someone inherits an IRA from someone who has passed on, the IRS typically establishes what’s known as an “inherited IRA”. This account usually comprises either a traditional or Roth IRA with both names listed; any contributions can only come in via beneficiary withdrawal.
As with other IRAs, distributions from an inherited IRA will be subject to your regular income tax rate. Converting it into a Roth IRA could increase your taxable income for that year and “bump” you into a higher tax bracket – potentially increasing both taxes as well as required minimum distributions over your lifetime.
To reduce its effects, consider converting your inherited IRA in stages over several years to spread out the conversion taxes and minimize impact. A financial professional might provide guidance around this; as the rules surrounding inherited IRAs can be complex.
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