If you are inheriting a traditional IRA and are well aware of retirement savings options, you may wonder if you can convert an inherited IRA to a Roth IRA. After all, Roth IRAs come with many benefits, such as tax-free income later in life and more control over withdrawal timing.
Can an Inherited IRA Be Converted to a Roth IRA?
If you inherit an IRA from someone who is not your spouse, you generally will not be able to convert it to a Roth IRA. Depending on whether the person specifically named you as a beneficiary, and except for certain cases such as disability or being a minor, you will generally need to empty the inherited IRA account within five to ten years.
What If I Inherit a Spousal IRA?
If you inherit an IRA from your spouse, the rules are different. In this case, the IRS provides two options. You can keep the inherited IRA in your spouse’s name, with your name listed as a beneficiary, which requires you to take required minimum distributions (RMDs) that you will be taxed on.
Alternatively, the IRS allows you to treat the inherited IRA as your own by listing your name as the account owner, and then you can do anything you want with it, including converting it to a Roth IRA.
How to Convert Your Late Spouse’s IRA to a Roth IRA
The rules for converting your inherited spouse’s IRA to your Roth IRA are essentially the same as for any other Roth IRA conversion, with some differences. Here’s how it will work:
- Make sure you can afford the tax impact: You will be required to pay taxes on the amount you convert. Be sure to know how much these taxes will increase your tax bill and that you can afford them in advance. Alternatively, you can do the Roth conversion over several years to spread out the tax impact.
- Make sure you have a Roth IRA: You will need to have a Roth IRA to hold the funds in. If you do not already have an account open, open one before you begin.
- Get a copy of your spouse’s death certificate: You will need a way to prove your spouse’s death so that you can take control of the account. A copy of your spouse’s death certificate will suffice.
- Contact the investment company that manages your spouse’s IRA: Reach out to the investment company that manages your spouse’s IRA to find out what requirements they have. For example, you may need to sign a spousal IRA claim form.
- Start the Roth conversion: You have two options to convert the inherited IRA from your spouse to your own Roth IRA. You can do a direct transfer between your spouse’s account and yours, or you can do an indirect transfer, where you receive a check that you must deposit into your Roth IRA.
- Pay the taxes: At the end of the year, you will pay taxes owed on the Roth conversion when you file your tax return.
Alternatives to Converting an Inherited IRA to a Roth IRA
If you have inherited an IRA from someone who is not your spouse, your options depend on several factors, such as whether the deceased individual specifically named you as a beneficiary. You will have one of these options:
- You were specifically named as a beneficiary: In this case, you will need to empty the inherited IRA account you inherited within 10 years.
- You are a specified beneficiary and meet certain conditions: If you are a disabled person or chronically ill, or closely related to the deceased individual (within a 10-year difference), or a minor, you may take distributions from the inherited IRA over your expected remaining lifetime.
- You have
You inherited an IRA without being specifically named as a beneficiary: If the court decides that you should inherit the IRA, your options will depend on the original account holder. If the person who passed away had already started taking RMDs, you will receive distributions according to their schedule. If not, you will need to empty the account within five years.
As you may notice, you may be required to start withdrawing funds from the inherited IRA immediately rather than at your retirement. If you do this from your own IRA, you will face a 10% early withdrawal penalty, but because this is a special case, this penalty is reduced for inherited IRAs.
Note: If you are obligated to make withdrawals from your inherited IRA based on your circumstance, make sure to do so. If you fail to do this, you will incur a penalty of 50% of the amount you were supposed to withdraw.
However, you will need to include any withdrawals in your taxable income for that year and pay taxes on them. Therefore, if you inherit a large amount and are facing time constraints, you can spread out the withdrawals over several years to lessen the tax impact. For example, if you inherit $1,000,000 as a named beneficiary, you can withdraw $100,000 annually to reduce the taxes owed on a million dollars of income taken all at once.
Once you withdraw the money, you can do whatever you want with it – including transferring it to your Roth IRA with regular contributions, as long as you meet the requirements. This will leave you with a larger amount in your Roth IRA, but it won’t have the same efficiency you would get from converting the inherited IRA alone.
Frequently Asked Questions (FAQs)
When is the best time to start converting an IRA to a Roth IRA?
Your situation and goals determine when is the right time to convert an IRA to a Roth IRA. If you are close to applying for Social Security and Medicare (two years or less), it is better to wait until after you start receiving those benefits so that the conversion does not affect those fees and taxes. If you are not earning much but your income will increase later, it is better to do the conversion now so you do not have to pay too much tax on the Roth conversion.
When do you pay taxes on a Roth IRA conversion?
You will pay taxes on the Roth IRA conversion when you file your tax return for that year. For example, if you convert to a Roth IRA in January 2023, you will not pay taxes until you file your return anytime between January 1 and April 15, 2024.
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Sources:
- Congressional Research Service. “Traditional and Roth Individual Retirement Accounts (IRAs): A Primer,” Page 21.
- IRS. “Publication 590-B – Distributions From Individual Retirement Arrangements (IRAs),” Page 6.
- Charles Schwab. “Why Consider a Roth IRA Conversion and How to Do It.”
- Merrill. “Can I Roll Over an IRA That I Inherit Into My Own IRA?”
Source: https://www.thebalancemoney.com/can-you-convert-an-inherited-ira-to-a-roth-ira-5224900
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