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Non-Sensical IRA and Roth IRA Items (Part 3 of 3)

I think we can all accept that the Tax Code is confusing. After all, it has to provide the rules for an extraordinarily vast array of circumstances. Sometimes though, the Code goes beyond merely confusing and borders on the bizarre. “Why would Congress do that?” you might ask yourself… and you’re not alone. While there are more than just a handful of bizarre items in the Tax Code, we’ve chosen to highlight three of them that relate directly to IRAs.

CLICK HERE to read Part 1 of this series.
CLICK HERE to read Part 2 of this series.

Below is the third and final installment.

IRA Beneficiaries vs. Plan Beneficiaries

When a beneficiary inherits a traditional IRA, they are stuck with a traditional style account for life. There is no provision that will allow them to convert that inherited IRA to an inherited Roth IRA. Beneficiaries of plan accounts [i.e. 401(k), 403(b)] however, do have an option. If they so desire, they can make a conversion of plan assets directly to a properly titled inherited Roth IRA.

For example, your father has just passed away and has left you his two retirement accounts, a $100,000 IRA and a $100,000 401(k). Believing that your future tax rate will be much higher, you decide you’d like to make a Roth conversion of dad’s accounts. The problem is though, only one of the accounts can be converted. Your father’s IRA can be moved into a properly titled inherited IRA and can be stretched, but it can never be converted to an inherited Roth IRA. The 401(k) however, can be directly transferred to an inherited traditional IRA, or it could be directly converted to an inherited Roth IRA. But you’d have to be careful. If you moved the money into an inherited IRA today, but realized tomorrow that the inherited Roth IRA was a better option… too bad. You’ve blown your shot. Once it’s in an IRA “wrapper” instead of a plan, an inherited account cannot be converted.

It doesn’t make any sense when you think about it. An inherited plan account can be converted to an inherited Roth IRA, but an inherited IRA can’t? What’s the reason for this disparity? Actually, it arose as an unintended result of several pieces of legislation and IRS guidance and Congress has yet to rectify the situation by passing legislation that would treat the two types of beneficiaries in a more equal manner.

-By Jeffrey Levine and Jared Trexler


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