Can an Inherited IRA Be Converted?
After an IRA account holder passes, beneficiaries have many choices available to them when dealing with their estate. One option could include rolling over assets into a new IRA under their own name.
This strategy offers tax-deferred growth while avoiding early withdrawal penalties of 10%. Before choosing this path, however, it’s advisable to consult a financial professional first.
Rollover
Beneficiaries can transfer an inherited IRA into their own account and follow all applicable contributions/distributions rules and RMD requirements, with any distribution taken prior to turning age 59 1/2 incurring an additional 10% penalty tax payment.
Nonspouse beneficiaries must close out an inherited IRA within 10 years from the year following its original owner’s death, either taking distributions over their life expectancy or choosing one-ten year period to disburse its entirety.
Navigating this complex area can be daunting, so beneficiaries might benefit from consulting a financial advisor. A good advisor will assist beneficiaries in considering their future needs, financial situation and taxes while helping to maximize the value of an inherited IRA – such as selecting growth-oriented investments if time allows or more conservative ones if withdrawal needs require immediate funds withdrawals.
Conversion
Over the next two decades, over $84 trillion will transfer from older generations to younger ones through inheritance or gift.1
Inherited IRAs present unique rules and distribution options that could have serious ramifications on their beneficiaries’ financial futures. To fully comprehend your options, the best approach is to consult a professional with experience managing these situations.
Spouse beneficiaries may roll their inherited IRAs over into their own accounts, while non-spouse beneficiaries have specific rules and options depending on their relationship to the original account owner.
Non-spouse beneficiaries can choose to assume ownership of an inherited IRA by designating themselves as the owner, and can convert the account to a Roth IRA, incurring taxes up front but potentially tax-free withdrawals in future withdrawals, provided it meets specific rules. A trustee-to-trustee direct transfer is usually the simplest way of doing this.
Withdrawal
An inherited IRA introduces several unique rules, such as how withdrawals are taxed. Working with a financial advisor to select the appropriate options for an individual’s particular circumstances is crucial to their long-term financial health.
Spousal beneficiaries can manage inherited IRA assets just like they would their own by moving funds from an inherited IRA account into their existing or Roth IRAs, giving them full control of when and how distributions should occur as if they were their original account owner, along with tax-deferred growth potential.
Non-spouse beneficiaries typically must empty an inherited IRA within 10 years after its original account holder passes away; however, if they’re under age 59 1/2 or chronically ill or disabled or younger than 10 years, stretch IRA options allow for more flexible distributions over their lifetime.
Beneficiaries can donate funds to charity in order to reduce taxable income and preserve future tax benefits, although this reduces future benefits. If you need guidance in understanding all your options for retirement planning, seek help from a fiduciary financial planner specializing in this area who can develop an appropriate strategy suited for you.
Taxes
Financial planners or attorneys specializing in estate planning could be of great assistance in understanding the rules surrounding an inherited IRA and developing a strategy for capitalizing on decades of tax-deferred compound growth.
if the original account owner died before 2020, nonspouse beneficiaries can elect to treat the IRA as his or her own and stretch RMDs over their life expectancies. After 2020 if it remains unchanged, beneficiaries must withdraw all assets within 10 years after receiving them as inheritance.
Converting an inherited IRA into a Roth is possible, and the best time is during a low-income tax year, prior to retirement or when in a lower tax bracket. When doing so, however, it’s essential that you utilize a qualified advisor and work with an IRA custodian that understands all of its rules associated with inheriting one.
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