Options For a Spousal Inherited IRA

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Elsewhere in this blog we’ve discussed inherited IRAs and how to handle them – but we have not covered all of the options for a Spousal Inherited IRA separately. There are some differences, specifically more options available, so this is an important topic. It should be noted that the majority of this article applies to inheriting IRAs or Qualified Retirement Plans (QRPs, such as a 401(k) or 403(b)), although the term IRA is used throughout. The receiving account must always be an IRA, though, when rolling over.

As a person who has a spousal inherited IRA, you have the following options if you are the sole beneficiary of the IRA:

• Leave the IRA where it is, and begin taking distributions based upon your own life (see Table I for the factors). This is the default position. If it works in your favor, you could also take distributions based on the original owner’s (your late spouse) lifetime.
• Rollover the IRA to an inherited IRA (see this post for more information). In this case, you’re treating the situation the same as if you were a non-spouse beneficiary.
• Rollover the IRA into an existing or new IRA in your own name. This is the special provision that spouses can use that a non-spouse beneficiary cannot. (Note: you could also leave the IRA where it is and just begin treating the account as if it was your own – more on this below.)

Rollover Into Your Own IRA

There’s nothing terribly complex about the mechanics of a spousal rollover of an inherited IRA – you simply put in motion the paperwork for a rollover, making sure that both the original custodian and the new custodian are aware of the fact that you’re taking advantage of this special provision for spouses. It is also possible to leave the IRA in place where it is and treat the IRA as your own – this will become the default if you 1) make a contribution into the account; or 2) fail to take the RMDs as if the account were inherited. This assumes that you’re not yet 70½ years old. You’ll still have to take RMDs when the time comes for them.

Now you have the IRA funds in your own account – which you can contribute to, convert to a Roth IRA, or whatever you’d like. Plus, if you’re under age 70½, you don’t have to start Required Minimum Distributions (RMDs) from the account. This brings up the one possible downside that you should be aware of as well, prompting a word of caution…

A word of caution

IF you go ahead and rollover the IRA from your deceased spouse’s account into an account in your own name and you’re less than age 59½, you do not have free access to the funds in the account – one of the 72(t) exceptions must apply, or you’ll be charged the extra 10% penalty in addition to taxes on the withdrawal. It is for this reason that many inheriting spouses do not take the IRA on as their own account – especially when there is a need to access the funds for income before reaching age 59½.

One more provision

As mentioned earlier, the provision for the spousal inherited IRA to treat the IRA as his or her own is generally for a spouse that is the sole beneficiary. There are two ways to resolve this situation if the spouse would like to rollover the account to her own IRA and there is more than one beneficiary.

1. Other beneficiaries could disclaim the inheritance, leaving only the spouse (see this article for more information). Many times, a well-intentioned IRA owner will designate her spouse and a child or grandchild (or a trust for the whole mob of children and/or grandchildren) as split beneficiaries of an IRA account. This can bring about unintended results, such as very young children having to take RMDs that they do not need. By disclaiming the inheritance and leaving only the spouse, the spouse can set up a new IRA in her own name, with the same original, now disclaimed, beneficiary or class of beneficiaries as the beneficiary(s) of the new account. This will fulfill the original owner’s intent, while opening up the account to the extra privileges available to an owner of an IRA versus an inheritant.
2. A somewhat less messy method is available – as a spousal beneficiary, but not the sole beneficiary, you can take a distribution of your entire share from the account, and then roll it over to an IRA in your own name, as long as it’s within the 60-day period following the distribution. You may need to make up the difference of the withholding – in general a distribution from an IRA will not be subject to 20% withholding, but from a 401(k) there will be mandatory 20% withholding of tax. If you don’t roll over the full amount into your own IRA, you will be taxed and perhaps assessed a 10% penalty on the amount that you did not roll into the new account. Using this method eliminates the disclaiming requirement which might be necessary if there are many other beneficiaries or if the other beneficiaries do not wish to disclaim. (Note:  This method is STRICTLY for a spousal inherited IRA. A non-spouse beneficiary will bust the stretch IRA by taking a distribution of this type, even if they rollover the amount into a properly-titled account within the time allotted. Those rollovers should ONLY be done via trustee-to-trustee transfer.)