Inherited IRAs and Roth Conversions
Take-Away: As a generalization, an inherited IRA cannot be rolled over by the designated beneficiary into a Roth IRA. However, the designated beneficiary who inherits a qualified plan retirement account can roll the inherited account into a Roth IRA.
Background: With the threat of higher income taxes looming, many individuals are seriously exploring the benefits of a Roth IRA. That includes those who expect to inherit a traditional IRA on the death of a family member. Thus, the question asked is whether an inherited IRA can be rolled over into a Roth IRA?
Traditional IRAs: The simple answer is that an inherited traditional IRA by a nonspouse designated beneficiary cannot be rolled over into a Roth IRA.
Surviving Spouses: The only exception to the general rule is that a surviving spouse can convert an inherited traditional IRA into a Roth IRA. A surviving spouse can roll the traditional IRA benefits inherited from the deceased spouse into a Roth IRA just as the deceased spouse could have done. However, this exception with traditional IRAs applies only to a surviving spouse.
Qualified Plans: The designated beneficiary of a qualified plan account, e.g. a 401(k) account, can roll the inherited qualified plan account into a Roth IRA. The rollover must meet the requirements of the Tax Code. [IRC 402(c)]. That Tax Code section does not prohibit rollovers from inherited qualified plans. Accordingly, a designated beneficiary of a qualified plan is entitled to direct a rollover of an inherited qualified plan retirement account into either a traditional IRA or into an inherited Roth IRA. [Notice 2008-30, 2008-12 IRB 638, A-7.]
Other Retirement Accounts: Included in the definition of a retirement account under IRC 402(c) are 403(b) annuities (e.g. school teachers) and IRC 457(b) governmental plan retirement savings accounts. Both these types of retirement plans incorporate IRC 402(c)(9) and (11) which permit nonspousal designated beneficiaries to convert inherited retirement accounts into Roth IRAs. This distinction between 402(b) annuities and traditional IRAs might be one reason why a retiring individual might maintain a 403(b) annuity to enable their designated beneficiaries to roll the inherited account balance into a Roth IRA, which could not be done if the 403(b) annuity was rolled into a traditional IRA.
Conclusion: As has been frequently mentioned in the past, it is dangerous to make the assumption that all retirement plan distribution rules are the same, whether for a traditional IRA, 401(k) account, or 403(b) annuity. We can only guess why the rules are different for different types of retirement vehicles, but they do pose a trap if one assumes that what can be done with one type of retirement account, e.g. an inherited 401(k) account, can also be done with an inherited traditional IRA. Would it be too much to ask from Congress for one set of distribution rules that everyone can understand and follow?