Inheriting the balance of a retirement account has become a much more common occurrence in recent years—meaning that clients increasingly have questions as to what, exactly, they can do with these funds in order to maximize their tax savings potential in future years.
One of these potential questions involves the possibility of rolling inherited retirement funds into an inherited Roth IRA in order to maximize tax-free income options in the future. The rules governing these types of rollovers are complicated—providing an accurate answer depends upon both the type of plan and beneficiary involved—and the inherited Roth account may be subject to distribution requirements that can potentially make this option less attractive to some clients.
Rolling Funds Into an Inherited Roth
Whether inherited retirement account funds can be rolled over into an inherited Roth IRA depends, first, upon whether the designated beneficiary is the original account owner’s spouse. If the beneficiary is a spousal beneficiary, he or she has the option of rolling the account balance into a Roth IRA regardless of whether the original account was a traditional IRA or an employer-sponsored plan (such as a 401(k)).
A non-spousal beneficiary of a traditional IRA, however, cannot transfer those funds into a Roth IRA because he or she is not permitted to do a rollover of the inherited IRA—and a Roth conversion is treated as if it were a rollover.
A non-spousal beneficiary of an employer-sponsored plan may be permitted to convert the inherited funds to an inherited Roth IRA if he or she is the designated beneficiary (meaning the beneficiary listed on the account beneficiary form, rather than one who inherits through the estate). The rollover must be accomplished through a direct trustee-to-trustee transfer into the inherited Roth IRA.
Pros and Cons of Converting to an Inherited Roth
For most clients, determining whether to convert inherited retirement funds to a Roth IRA first involves consideration of the tax consequences—the amount converted will be included in the beneficiary’s income in the year of conversion. Therefore, if the beneficiary is in a low income tax bracket in the year of conversion, the strategy may prove attractive (especially if he or she expects to move into a higher tax bracket in the future).