Can You Convert an Inherited IRA?
Before making any investments, it’s essential to consult a qualified tax or financial professional for advice. In general, non-spouse beneficiaries cannot commingle the assets from an inherited IRA or 401(k) with assets from their own IRAs or work-related retirement accounts.
Beneficiaries may wish to convert the funds in an inherited IRA into another investment vehicle to avoid tax consequences of distributions, but should consider their personal tax situation and potential rate of growth of this inherited IRA before doing so.
How to Convert an Inherited IRA
After the death of a loved one, you may inherit their retirement savings as an act of generosity and can help secure your own future plans. But inheriting an IRA has specific rules you must abide by before proceeding with this gift.
Inheriting an IRA requires that all assets be moved from its custodian into your name by way of a trustee-to-trustee transfer. Your new account may be labeled as either “IRA inherited by” or simply individual retirement account. An inherited IRA cannot be combined with any existing retirement accounts you hold but could potentially be transferred via trustee-to-trustee transfer if that becomes necessary.
Tax rules surrounding the inheritance of an IRA can be complex, so it’s wise to consult a financial professional prior to taking any steps. Furthermore, married individuals may have more options. They could treat the IRA as their own and follow distribution rules as if it had always been part of their estate plan.
Roth Conversion
Surviving spouses are only eligible to convert inherited traditional IRA funds to Roth assets. If this strategy interests you, make sure all calculations have been run before submitting any paperwork for conversion – be sure to cross all i’s and dot all t’s before beginning this journey.
Non-spouse beneficiaries who inherit assets in an IRA may be required to withdraw them within 10 years after its original account holder dies, increasing incomes and pushing them into higher tax brackets; conversion to Roth can help lighten this burden.
Depending on when and how your income changes in future years, delaying Roth conversion might make sense. Or you could spread it out over more years for maximum tax efficiency and reduced overall impact in each year of conversion. Either way, Roth conversion can become part of a comprehensive retirement planning strategy; seeking professional guidance when considering whether converting an inherited IRA makes sense is also crucial in making decisions like these.
Traditional Conversion
Non-spouse beneficiaries cannot combine an IRA they inherit into their own IRA account; rather, assets must be moved to their name in an entirely separate IRA account. There is an exception with traditional, SEP, and SIMPLE IRAs where beneficiaries are permitted to combine inherited assets with their existing account.
When done by non-spouse beneficiaries, this could reduce their tax bill from required minimum distributions (RMDs). It could make sense in years when income is lower than usual to pay taxes on their inherited assets upfront rather than having them taken out later from growing funds – which may help further lower tax bills over time. Converting assets over several years may further lower tax costs; but before going ahead it would still be wise to consult a financial or tax advisor as it’s impossible to anticipate future tax rates and brackets accurately.
Rollover
If you are the non-spouse beneficiary of an IRA or 401(k), it is advisable to consult a fiduciary financial and estate professional before making any moves with these accounts, particularly if deciding to transfer an inherited IRA to a new custodian.
If your account is a traditional IRA, any rollover must take place within 60 days to avoid incurring tax bills. Converting into a Roth IRA also results in tax charges being applied;
Once you assume ownership of an inherited IRA (sometimes known as taking over an account), IRS rules treat it as though it has always been yours, allowing contributions and distributions based on your life expectancy rather than that of the deceased IRA owner. You are required to take required minimum distributions by December 31 of the year after their death; at this point it would be wise to consult a fiduciary financial professional in order to plan accordingly.
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