Can I still completed a backdoor Roth conversion if I have a large inherited IRA?

Can I still completed a backdoor Roth conversion if I have a large inherited IRA?
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#1

Hi,
I have a traditional IRA account with nothing in it because I just opened it this year. I also have a Roth IRA (with a little in it because I opened it a few years back). My wife, who I file with jointly, has the same setup.

We are no longer eligible to contribute to the Roth. So, I would like to contribute to our traditional IRAs and convert to the Roths.

But, just two years ago, I received an inherited IRA with about 200K in it. From what I am reading, this has a major impact on my Roth conversion, and likely makes it not worth it. I just want to make sure that I understand that correctly. Is the problem that, after doing the conversion, almost the entire contribution will be taxable… when I take it out years from now? That’s what I don’t get. When is this taxing taking place? I have already paid taxes on the contribution, do I pay again when it gets converted?

Lastly, if the inherited IRA negates the reason for converting my contribution to a Roth, would it cause the same problem for my wife? I was the beneficiary on the inherited IRA. Would this account figure into the equation for my wife’s IRAs and the ability to roll over contributions between her accounts?
Thanks,
Rich


#2

[Edit: answer rearranged for better reading flow and more direct answer of the question. LM]

Your Inherited IRA, Traditional IRA, and Roth IRA all need to be viewed as separate vehicles.

The so-called "Back Door Roth Conversion" is a strategy applied only to conversions from your Traditional IRA. If you make a non-deductible contribution to a Traditional IRA and subsequently convert it to a Roth IRA ("back door conversion"), you will only pay tax on any gain to the point of conversion. Then, provided you leave the funds in your Roth IRA until age 59.5 (or the 5-year Roth rule, whichever is later), you won't pay taxes on any of the growth.

Your Inherited IRA has no affect on the Back Door Roth Conversion strategy. With your Inherited IRA, you must withdraw funds each year, called Required Minimum Distributions (RMDs). The actual amount you must withdraw changes each year based on the December 31 balance of the Inherited IRA in the prior year and the "life expectancy factor" (IRS table) for your age at the end of the year.

Assuming the original IRA owner made the contributions pre-tax, you'll pay income taxes on all amounts you distribute from the Inherited IRA. Distributions get added to your other income and are taxed at ordinary income rates, just as if you earned that amount in additional salary.

You cannot transfer your Inherited IRA into your Traditional IRA, nor can you convert it to a Roth IRA. It must be kept separate and is subject to different requirements than the others.

Hope that helps. All the best!


#3

Patricia gave an excellent detailed outline of the backdoor considerations for converting to a Roth. The only think  I didn't see covered in the other answers is whether you are taking required distributions from the inherited IRA. You had to make an election to either stretch your withdrawals over your lifetime based on the IRS life expectancy table, a lump sum or the 5 year election that says you must remove all of the money within 5 years, but you can time the distributions to have the least tax impact.

As was pointed out, an inherited IRA cannot be combined with any of your own IRA's, so if you transferred it to a different account when the owner died, the folks who did the paperwork should have kept it classified as an inherited IRA. Check your statement or account papers to make sure.


#4

I don’t know how old this post is, but if your inherited IRA is titled correctly, it should not be included in the pro-rata rule.
If you have nothing in the applicable IRAs, any back-door Roth amounts should be all or mostly tax-free. My Back-door Roth guide my help:
http://sonafinancial.us13.list-manage.com/subscribe?u=26e44f1c8b78433d53dbe25c3&id=54f798e999
Good Luck!
Mark Struthers CFA, CFP®
www.SonaFinancial.com
For Sona’s Educational Series KnowThis! KnowThat! go to:
http://sona-financial.thinkific.com/
This is for informational purposes only. Your specific situation would need to be taken into account. All information is subject to change. Not to be considered investment, tax, or legal advice.


#5

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