Can You Convert an Inherited IRA?
An inherited IRA may provide significant tax advantages. Before making any decisions regarding it, however, it’s wise to consult a financial advisor and review all options carefully.
Nonspouse beneficiaries who inherit an IRA typically have three options when inheriting it: they can either assume ownership by designating themselves as the account holder; roll it into their own IRA (traditional or Roth), or disclaim it.
Distribution Rules
Tax laws surrounding inherited IRAs can be complex, and details will differ depending on your relationship to both account owners and beneficiaries. Beneficiaries should seek professional financial advice regarding this aspect of tax law for best results.
Spousal beneficiaries may treat an inherited IRA as their own; non-spousal beneficiaries must open a separate account in their name to take on management of it, including setting their own investment choices and time distributions to reduce taxes.
However, non-spouse heirs of an IRA account must begin taking required minimum distributions (RMDs) by December 31 of the year following their owner’s death. This eliminates the option of spreading withdrawals over one’s lifespan without meeting one of several exceptions to this rule. As a result, experts often advise heirs seeking expert guidance for assistance when managing an inheritance IRA.
Beneficiary Options
Beneficiaries have various options available to them when taking distributions from an inherited IRA, each of which may have tax repercussions depending on the circumstances. If you are the spouse of the deceased account owner, rolling their assets over into your own IRA could allow for decades of tax-deferred growth.
Non-spouse beneficiaries have few choices available to them when it comes to distributions from accounts held by non-spouse beneficiaries. If the original account holder was of required minimum distribution (RMD) age, you can assume ownership by rolling their IRA over into your own via direct trustee-to-trustee transaction and starting taking RMDs based on either your life expectancy or that of their single life expectancy remaining single life expectancy.
If you don’t feel prepared to use the money that has been given to you as part of an inheritance, disclaiming assets within nine months of its original account holder’s death can save you from paying a 10% early withdrawal penalty.
Annuity Options
Assuming you inherit an IRA as a non-spouse beneficiary, withdrawal rules can be intricately detailed depending on your relationship to its original owner and their age when they passed away. One option available to non-spouse beneficiaries would be taking distributions over their life expectancy (known as stretch provision) so as to minimize tax liabilities while still allowing the account balance to accumulate tax-deferred over more years.
Alternately, beneficiaries can roll an inherited IRA into their own traditional or Roth IRA account and continue following retirement plan rules regarding contributions/distributions/RMDs etc. Spouse beneficiaries may treat an inherited IRA as their own and withdraw assets as though it were created themselves at its inception.
Inheriting an IRA can be both complex and financially advantageous for some. A financial professional can provide guidance regarding payout options, distribution rules, and any tax implications of inheriting one.
Roth Options
Parents, spouses and grandparents often want to leave behind an inheritance of financial security for their loved ones after they pass. One way of doing that is leaving retirement assets in an IRA account for beneficiaries to inherit; however, the rules must be adhered to and professional advice sought when handling an inherited IRA account.
IRAs may be transferred between accounts, though the original account owner must take their required minimum distribution (RMD) by year end or face up to 25% in penalties. Beneficiaries can roll over an IRA into their own IRA via trustee-to-trustee transfer or by taking out and reinvested within 60 days.
If their IRA is traditional, beneficiaries can elect to convert it to a Roth IRA, which could prove advantageous depending on future tax rates and eligibility requirements. Once converted, distributions from such an account can be made tax-free as long as they continue meeting Roth guidelines.
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