Inherited IRA Strategies for Surviving Spouses
By Kimberly Polaski
When a spouse inherits an IRA from their deceased husband or wife, there are several planning strategies that the surviving spouse can follow to suit specific needs. Spouses who are designated the sole beneficiary of the IRA have special options that are not permitted for other beneficiaries. Choosing the correct one for the surviving spouse’s circumstances can be a powerful tool for minimizing income, taxes, IRS penalties, and maximizing the tax deferred attributes of the account. Each strategy has advantages and disadvantages.Option 1- Receive a Distribution for the Amount of the IRA
This option is available to all beneficiaries of IRA’s, whether the beneficiary is the spouse of the decedent or not. Distributions made to a beneficiary from the decedent’s IRA after the decedent’s death is exempt from the 10% early withdrawal penalty.
- Receive lump sum of money immediately; avoid 10% early withdrawal penalty.
- The distribution is taxable, and depending on the size of the distribution, could raise the beneficiary into a higher tax bracket in the year of the distribution.
A surviving spouse can make an election to treat the decedent’s IRA as if it were their own. This election can be made by the spouse changing the account to one in his or her name as the IRA owner, or it will be made automatically if the spouse begins to contribute money into the account or take other actions that are consistent with being the owner of the IRA. With this option, the existing monies in the inherited IRA are treated as if the surviving spouse contributed it all themselves.
- The beginning date for required minimum distributions will be deferred until the spouse turns 70 ½ (if the spouse is younger than the decedent); the spouse can use the Uniform Lifetime Table to determine the required minimum distributions rather than the less favorable single life expectancy; the spouse can name his or her own beneficiaries and increase the lifespan of the IRA.
- Unless an exception is met, the spouse will be subject to tax and the 10% penalty on all distributions taken before he or she turns 59 ½.
A surviving spouse can decide to roll-over the funds from the decedent’s IRA into his or her own IRA. Similar to the election in Option 2, the funds in the roll-over IRA will be treated as the surviving spouse’s own.
- Same as Option 2- More favorable rules for Required Minimum Distribution, including beginning date; ability to name own beneficiaries.
- Same as Option 2- generally, tax and penalty will be due on any distributions taken before the spouse turns 59 ½.
As previously stated, a significant 10% penalty is charged by the IRS for any distributions made before the owner of the IRA is 59 ½ years old. So for certain younger spouses, it may be best to not make the election or roll-over the funds until the spouse is old enough to avoid the penalty. The election or roll-over can be made any time after the death of the decedent. As such, distributions from the decedent’s IRA to a beneficiary are exempt from the 10% penalty. In this option, the spouse would be free to take any amount of distributions while the IRA is still in the decedent’s name and only have to pay the income tax. The surviving spouse can then make an election or roll-over the funds to their own IRA once he or she is old enough to receive the benefits.
- Avoid 10% penalty on pre- 59 ½ withdrawals; receive benefits of election/roll-over after age 59 ½.
- Any lump-sum distributed while the IRA is in the decedent’s name is subject to tax in the year of the distribution; inability to appoint own beneficiaries until the roll-over or re-title occurs.
When a spouse inherits an IRA from their deceased husband or wife, it is crucial that he or she evaluate which option would work best for them in their unique circumstances. The potential IRS penalties and income tax imposed on any withdrawals can be significant, and may be avoided with the proper planning.
Please consult your Marcum tax advisor should you have questions related to an IRA withdrawal.