Inherited IRA disqualifies me from a ROTH IRA

Submitted by Alon David on Fri, 2021-08-13 18:05

Hi I recently inherited a 401k that I rolled over to a Beneficiary IRA. Throughout the next ten years I have to empty out the whole IRA. This means I have chosen to make yearly distributions to myself as ordinary income. However this income puts me over the limit to have a ROTH IRA. My plan for this money is to just invest it anyways for the long term. Can I open a solo 401k for this money and contribute to it then convert to a Roth to have this money grow without any tax liability. I could satisfy the $19,000 401k contribution limit then use the remainder sum to the ROTH IRA (if I understand the process correctly).

But here is my question:

1. After I take this distribution from the BIRA and I pay ordinary income tax on that amount. Do I have to pay taxes again when contributing to this solo 401k or when I convert to a Roth?

2. Is there a way to go directly from the Beneficiary IRA to a solo 401k?

3. Is this even beneficial for this situation? What would be an alternative route to obtain a Roth IRA or any post tax account?

Thank you



Submitted by Alan - IRA critic on Fri, 2021-08-13 22:32

You are self employed only, and do not have a job that offers an employer plan? Do you have a balance in a traditional, SEP, or SIMPLE IRA now?

Submitted by Alon David on Fri, 2021-08-13 23:39

I currently work for a company that does not offer an employer plan. I do not have a balance in a traditional, SEP, or Simple IRA.

Submitted by Alan - IRA critic on Sat, 2021-08-14 02:50

You must have self employment income to adopt and contribute to a solo 401k. You cannot use your earnings from your employer that does not offer a plan. However, you could do a back door Roth IRA since you do have earned income. You could make a non deductible TIRA contribution and then quickly convert it to a Roth IRA tax free, reporting both the ND contribution and the conversion on Form 8606. 
If you do have self employment income, you could adopt a solo 401k and if you have enough SE income you could contribute up to 19,500 and deduct it, or you could open a Roth solo 401k and make after tax contributions instead. You cannot convert from a pre tax solo K to a Roth IRA until you cease self employment or reach 59.5.

Submitted by William Tuttle on Sat, 2021-08-14 13:40

As Alan pointed out you must be a self-employed individual defined in 401(c) to adopt, maintain and contribute to a one-participant 401k. If this is true, E-Trade offers a designated Roth account for Roth contributions. To my knowledge, they are also the only mainstream provider to offer an in-plan Roth rollover of pre-tax assets. However as also pointed out by Alan, you can not rollover distributions from inherited accounts to any other account.

Submitted by Alon David on Sun, 2021-08-15 04:13

I guess my question stems from whether I could change my status to self employed for these purposes. Could I create an LLC or DBA soley for these distributions that I am receiving from the Beneficiary IRA? There is enough in yearly distributions from BIRA to meet the $57,000 limit. My strategy is to take these taxable distributions from the BIRA then contribute it to a solo 401k for this DBA or LLC (whichever is required) then convert those funds to a roth solo 401k, thus executing the Mega Roth/ Backdoor Roth strategy. Is this possible? I do have a side business that I am currently pursuing but it is not my main source income. Could I use this side business to qualify as being self employed and thus execute the solo 401k? I would still be receiving a paycheck from my employer.

Submitted by William Tuttle on Sun, 2021-08-15 13:53

You must have self-employed earned income from a trade or business in the current or any prior year to adopt maintain and contribute to a one-participant 401k.
Self-employed earned income can certainly come from a side business when you have W-2 compensation
However, one-participant 401k contributions must only come from and are limited to self-employed earned income.
Distributions from inherited retirement accounts are unearned income and can not be the basis for any retirement contributions.

Submitted by William Tuttle on Sun, 2021-08-15 14:00

You must have self-employed earned income from a trade or business in the current or any prior year to adopt maintain and contribute to a one-participant 401k.
Self-employed earned income can certainly come from a side business when you have W-2 compensation
However, one-participant 401k contributions must only come from and are limited to self-employed earned income.
Distributions from inherited retirement accounts are unearned income and can not be the basis for any retirement contributions.

Submitted by Alon David on Mon, 2021-09-06 18:19

Would this be an alternative strategy if I chose to invest these inherited funds in an IRA?To use the backdoor Roth IRA strategy, you’ll need to take the following steps:
Open a traditional IRA with your IRA custodian of choice.
Make a fully nondeductible contribution to your traditional IRA. The contribution limit for tax years 2020 and 2021 is $6,000, plus an additional $1,000 catch-up contribution for those aged 50 and above. 
Next, convert the traditional IRA balance into a Roth IRA. 
Is there a limit to how much income I would be able to do this with? Does it only apply $6,000.00 total or can it be done $6,000.00 at a time? Like does the conversion not count toward the Traditional IRA threshold. The place I found this strategy doesn’t mention the need for a solo401k involved at all. Thank you

Submitted by Alan - IRA critic on Mon, 2021-09-06 19:59

That would work to enable a Roth contribution via the back door process. There are no maximum income limits to make a non deductible TIRA contribution, but the annual IRA contribution limit of 6000 (plus catch up if eligible) applies. You can then do a “back door Roth” by converting the contribution immediately to a Roth IRA. The pro rate rules will not affect you since you do not own another TIRA, SEP, or SIMPLE IRA, and the inherited TIRA does not count. Therefore, your conversion will be non taxable except for perhaps a very small of amount of gains before you convert. Since the conversion is non taxable, you can withdraw it from the Roth penalty free under the Roth IRA ordering rules without waiting 5 years.

Submitted by Alon David on Mon, 2021-09-06 22:29

Is the maximum $6000 altogether (contribute to TIRA then convert to RIRA) and thats it? Or is it something that can be done $6000 at a time? But I could convert more altogether?

Submitted by Alan - IRA critic on Tue, 2021-09-07 02:57

Your annual contribution limit is just 6000 if under 50. If you had another TIRA in addition to your 6000 annual contribution, you could convert more, but you do not have another TIRA, and if you did the conversions would be mostly taxable. With no other TIRA account, your conversion of the 6000 annual contribution will be non taxable.

Submitted by Bruce Steiner on Mon, 2021-09-06 21:46

At the cost of bunching the income into a single year, you could have rolled the 401(k) benefits into an inherited Roth IRA rather than an inherited traditional IRA.  Did you discuss this choice with the lawyer handling the estate, or with the lawyer who handles your estate planning?
Bruce Steiner

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