If you've inherited an individual retirement account, you can keep the assets growing tax-free in the IRA for a longer period of time by taking only the required minimum distribution each year over the remainder of your life expectancy rather than emptying the account all at once. Even though you're not allowed to roll over those distributions to a Roth IRA, there's nothing stopping you from using your extra cash from an RMD to fund your Roth IRA. However, you're going to need other taxable compensation to contribute to a Roth in the first place.
According to Internal Revenue Service Publication 590, you're not allowed to roll over an RMD -- including those from an inherited IRA -- to another retirement account. If you meet the eligibility requirements to contribute to a Roth IRA but you contribute more than the annual limit, any money that you take from the RMD and put in a Roth IRA will count as an excess IRA contribution. Excess contributions are hit with a 6 percent penalty every year that you don't correct the excess contribution.
Roth Eligibility Requirements
Just because you have extra cash you want to save doesn't mean you're allowed to put money in a Roth IRA. To be eligible, you must have taxable compensation for the year and your modified adjusted gross income can't exceed the annual limits for your filing status. Taxable compensation includes your wages, self-employment income and alimony received. However, investment income, IRA RMDs and gifts don't count.
As of 2014, if you are married and filing jointly, a qualifying widow or a qualifying widower, you can't contribute to a Roth if your modified adjusted gross income is $191,000 or more. If you are single, head of household, or married and filing separately and you do not live with your spouse at any time during the year, you can't contribute if your AGI is $129,000 or more.
No Tracing of Deposits
Even though you must have taxable compensation to contribute to a Roth IRA, the IRS doesn't require that you use only taxable compensation to do so. That means you don't have to be able to trace your contribution back to your wages. For example, say you inherited an IRA from your parents and you've elected to take annual distributions over your life expectancy. The IRS doesn't care whether the dollars that you put into your Roth IRA for the year came from the IRA distribution or from your paycheck, as long as you meet the Roth IRA eligibility requirements.
As of 2014, you're allowed to chip in as much as $5,500 per year to your Roth IRA if you're under 50 years old -- as long as you have at least that much in taxable compensation for the year. If you have less earned income, your taxable compensation for the year is the limit. For example, if you were unemployed for most of the year and earned only $3,000, you can't contribute more than $3,000 even though the general limit is $5,500. So, even if you had to take an RMD of $7,000 from your inherited IRA, you could only put $3,000 into the Roth IRA as an annual contribution.
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