Roth Rollover Rules for a Non-spouse Beneficiary

Roth rollover rules permit you to convert your business retirement plan assets, which include a 401(k), 403(b), as well as 457 plans, directly to a Roth individual retirement arrangement. However, most don't take this option because the tax bill on converting pre-tax assets from a traditional pre-tax 401k to a post-tax Roth IRA can be significant. Often, at the time of retirement or death of the account owner, when a rollover is considered, most take the tax-free route and rollover to a traditional IRA. Later, when the parties realize the benefits of the Roth IRA, they can convert this traditional IRA to a Roth IRA and pay the tax.

However, if the beneficiary of the 401k is a non-spouse, the Roth rollover rules are more restricted. At the time of the rollover he must make an irrevocable decision to rollover funds to a traditional IRA or Roth IRA and cannot transfer between the two in the future. What are his alternatives and what should he do?

A non-spouse beneficiary of a company plan can only rollover funds into an 'inherited IRA' - either the traditional IRA or a Roth IRA. But a pre-tax "inherited IRA' can't later convert into a Roth IRA. So if he wants that cash to go into a Roth account, he must make that decision at the time of transfer to have a 401k rollover to Roth IRA.

Roth Rollover Rules and Inherited IRAs

Whether converting the plan income to a traditional or Roth individual retirement arrangement, he must do a direct rollover (i.e. trustee to trustee). Should the non-spouse beneficiary take possession of the funds at any time during the process (e.f. receive the check), this is deemed a distribution and the funds cannot be rolled over.

The non-spousal beneficiary is impacted by the same Roth rollover rules as the owner of the account would be concerning issues such as taxes regarding withdrawals in the first 5 years. Also, like the owner or perhaps spousal beneficiary, he must have the money to cover the taxes on the conversion beforehand. Note that the penalty for withdrawals prior to age 59 1/2 are waived for a beneficiary.

Unlike the owner or even a spousal beneficiary, Roth rollover rules require a non-spouse beneficiary to make required minimum distributions (RMDs) starting the year after the death from the owner. These distributions are tax free. The IRS purpose is to deplete the account over the life of the beneficiary so that these tax free plans cannot be passed on forever, generation after generation.

Why convert to the Roth IRA? What are the Roth rollover rules you need to know?

If the non-spouse beneficiary has the capacity to pay the taxes for the Roth conversion process and is still young, the particular conversion can be advantageous. In the event that he's young - for example age 33 - with an Internal Revenue Service life expectancy of 50 years, his Roth IRA could very well grow considerably because of the reasonably small required annual withdrawals (starting at 2%). The included figure below shows the increase in price per $10,000 initial investment over the 50 year period removing only the required distributions.

Two other great things about completing a Roth rollovers are:

The money is available tax free - perhaps to repay whatever was borrowed to pay for the upfront taxes.
Because the Roth distributions are tax free, they can never be subject to potentially increasing income tax rates -as a traditional individual retirement arrangement would be.

Please consult your IRA custodian to understand the Roth rollover rules.