Can You Convert an Inherited IRA?
Once an IRA or workplace retirement plan beneficiary passes away, their account will be moved into an “inherited IRA”, where they can follow the same distribution rules as they would have had they owned it themselves from day one.
Non-spouse beneficiaries, on the other hand, must liquidate their accounts within 10 years or face an enormous income tax bill – creating an uphill battle for many beneficiaries.
Taxes can be an issue when inheriting an IRA, so one option for inheritors may be keeping the money within an inherited IRA or beneficiary IRA and taking required minimum distributions throughout your life expectancy. This strategy could work if you or family members inheriting have lower incomes and therefore are likely to fall within lower tax brackets than when originally inheriting it.
Spouses may also roll their inherited IRA assets into an IRA in their own name and treat it as their own; this can be beneficial if they anticipate paying more taxes in retirement than the original account owner. A financial professional in the family can assist heirs through all available options and any possible tax implications.
Prior to making decisions about an inherited IRA, beneficiaries must understand its rules. For instance, RMDs — required minimum distributions at age 70.5 or later each year from an IRA account — differ depending on whether or not you are spouse-dependent beneficiary; furthermore, an inheritance can alter your tax bracket significantly.
Beneficiaries have two options when inheriting an IRA: they can either treat it like their own by becoming the account holder and withdrawing according to its original owner’s rules, or roll its contents into an existing IRA and pay income tax on any taxable distributions plus face an early-withdrawal penalty of 10% if taking money before age 59 1/2. Working with a financial professional before making decisions about an inherited IRA is important – this way beneficiaries can make the best choice for themselves while making use of its potential tax-deferred or tax-free growth potential.
Tax rules surrounding inherited accounts can be complicated, so seeking advice from an experienced tax professional is usually the best way to ensure compliance with all requirements.
Survivors of individual retirement accounts who are unmarried typically can roll over all or part of an inherited IRA into his or her own IRA within 60 days, either directly with trustees or taking distributions and depositing them within that same timeframe into another IRA.
This strategy allows an IRA balance to benefit from tax-deferred growth while giving beneficiaries access to funds without penalty. As another option, beneficiaries may take a lump sum distribution and pay income taxes on any portion that’s taxable – however this could increase tax bills while potentially jeopardizing tax-deferred growth potential. Survivor spouses of deceased spouses can rollover an entire traditional IRA into a Roth IRA as the deceased could have done.
As an inherited IRA is not yours, you cannot use it to make contributions, roll assets over to another IRA or convert to Roth using traditional means. Instead, funds may be directly transferred from it into another Roth via trustee-to-trustee direct transfer between accounts or custodians.
Transferring between accounts may also help convert traditional IRAs to Roth IRAs, or from one of the other types such as SIMPLE or SEP accounts, with taxes applicable depending on whether pretax or post-tax dollars are involved in conversion.
Non-spouse beneficiaries could face the possibility of higher taxes with an IRA conversion, potentially altering tax deductions and credits, increasing Medicare Part B and D premiums, and potentially becoming subject to the 3.8% net investment surtax. It’s wise for non-spouse beneficiaries to seek advice from both a fiduciary financial professional and estate specialist when making this decision.
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