Can an Inherited IRA Be Converted?
The 2019 SECURE Act significantly modified IRA rules. Now, non-spouse beneficiaries must close out the account within 10 years or face tax consequences.
Before making decisions regarding an inherited IRA, always seek advice from a financial professional. A sound strategy can help reduce fees and taxes while simultaneously increasing growth potential.
Rollover
Surviving spouses can treat an inherited IRA as their own by rolling its assets over into an IRA under their name, or transfer the deceased spouse’s plan into a Roth IRA if desired. Rollovers may incur tax implications that are unexpected; therefore it’s wise to consult a financial advisor prior to taking action.
Beneficiaries can avoid paying an early withdrawal penalty of 10% by converting an inherited traditional IRA to a Roth IRA before turning 59 1/2 and paying taxes on what has been converted. However, they will incur taxes on any amounts converted.
Nonspouse beneficiaries have more choices, though distributions must begin by December 31 of the year following an account holder’s death. They can choose to have payments spread out over their life expectancies or those of the deceased account holder (whichever comes first) – or alternatively take them in one lump sum payment.
Conversion
As soon as an IRA owner passes, their assets must be moved into an “inherited IRA”, an account which cannot receive additional contributions but only can be used for withdrawals. An “inherited IRA” could include traditional, Roth or other types of IRAs – non-spouse beneficiaries may even inherit employer plans such as 401(k)s or 403(b).
Dependent upon who the deceased IRA owner was, a surviving spouse may convert an inherited IRA into a Roth IRA in order to avoid tax liabilities on distributions that might otherwise be subject to regular income tax rates and RMDs in years one through nine. A conversion might increase tax liabilities initially but should lower beneficiary’s taxable income over time; non-spouse beneficiaries cannot convert an inherited IRA into a new Roth IRA.
Withdrawals
Withdrawals from an inherited IRA must comply with certain rules, and their tax impact varies based on each individual situation. As a general rule, all distributions from an inherited IRA must be taken within 10 years after inheriting it; any withdrawals for non-spouse beneficiaries typically become income and taxed at ordinary income rates.
Inherited IRAs must make required minimum distributions (RMDs) every year after the original account owner dies, to prevent it from continuing to accrue tax-deferred growth forever.
Non-spouse beneficiaries who decide to rollover an inherited IRA must do so using a direct trustee-to-trustee transfer to an IRA established for this purpose; otherwise, funds will be taxed as distributions and should be treated accordingly. An experienced financial professional can help assess all available options and select one suitable to their situation; remember, an inheritance from an IRA can be significant, so making wise choices now could have long-term effects on retirement income.
Taxes
Trustees who inherit assets in an account will owe taxes at ordinary income rates on them; further, withdrawing amounts could push beneficiary owners into higher tax brackets or unlock deductions and credits that weren’t previously intended to apply.
Beneficiaries must begin receiving required minimum distributions (RMDs) within a year after the death of the original account holder, even if they’re not yet 70.5. RMDs will then be calculated based on either their single life expectancy or that of their decedent, whichever one is longer.
Exceptions exist if you are the spouse or minor child of the deceased person or are chronically ill, although disclaiming an IRA asset and refusing distributions will allow it to pass to its next eligible beneficiary instead of adding taxes. Consult a financial professional before choosing this path as it could reduce overall taxes significantly.
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