There are many considerations taken into account in determining what a surviving spouse can and should do with an IRA received from a deceased spouse. Breaking down each consideration will simplify the decision-making process and help determine how to handle this important asset. Below is a breakdown of the options and considerations for a surviving spouse who has received a traditional IRA as a designated beneficiary.
First, a person receiving an IRA from a deceased IRA owner generally must begin taking minimum distributions following the death of the account holder. However, in the case of a surviving spouse beneficiary the distributions would be based on the surviving spouse's life expectancy if the predeceased spouse has not yet reached the age where they were required to begin taking distributions (i.e. 70 1/2 years old). If, on the other hand, the predeceased spouse has begun taking his or her required distributions, then the surviving spouse may take distributions over the spouse's life expectancy (recalculated annually). But you, as the surviving spouse, can elect to take over a period of time shorter than any of the above situations should you so choose. The other option a surviving spouse has is to wait until the predeceased spouse would have reached the age of 70 1/2 years old to begin taking distributions, if the spouse has not yet begun to take required distributions.
Second, after deciding the timing of distributions, a decision needs to be made as to how to hold the funds. In addition to deciding whether you want to begin taking distributions now or later, you have the ability to take distributions from the account as it stands, change the name on the account to your own name or roll the assets of the account into your own IRA. The latter option is available only where the spouse is the sole beneficiary and has an unlimited right to withdraw amounts from the IRA, but this can frequently be accomplished by segregating the funds into a separate account.
The decision on how to hold the funds will again depend on the surviving spouse's financial goals. Typically, the goal is to defer taking payments as long as possible so that the surviving spouse is retired and taxed on the income while the surviving spouse is in a lower tax bracket. Therefore, if the surviving spouse is younger than the predeceased spouse it may be more advantageous to roll over the IRA into the surviving spouse's name. If this occurs, the surviving spouse is treated as the owner of the account for all purposes and is required only once the surviving spouse reaches the required age for distributions (currently 70 1/2 years old). If, instead, the surviving spouse is older than the predeceased spouse it may be more advantageous to leave the assets in the predeceased spouse's IRA and begin drawing at the later of either: (1) December 31 of the calendar year after the predeceased spouse died; or (2) December 31 of the calendar year in which the IRA owner would have attained age 70 1/2. If the surviving spouse chooses to leave the IRA in the predeceased spouses name the surviving spouse must take distributions over the surviving spouse's life expectancy or a shorter period.
Finally, you should know the timing of taxation to make an informed decision. Regardless of how and when you take your distributions, you will be required to claim this income on your taxes and will be taxed based on your income tax bracket. This is because it is a Traditional IRA on which tax has never been paid. Generally, you will be taxed in the year you receive the payout. Thus, if you take it as a lump sum, you will be taxed on the total immediately. If you elect instead to receive income via distributions, you will be taxed at the time of each distribution. If you were to transfer the account to another person, then you would be taxed on the entire IRA at the time of the transfer to that individual. However, if you roll over the IRA into another retirement plan, there will be no tax until those funds are withdrawn. The same will apply if you decide to treat the predeceased spouse's IRA as your own.
In addition, distributions made before the predeceased spouse would have attained the age of 59 are generally subject to a 10% penalty. However, distributions made to the participant's death beneficiary are not subject to this penalty. This applies even if the payments are by distributions. But, if you are under the age of 59 and roll over the payments to an IRA in your name and then seek to withdraw you will be subject to the 10% penalty (though planning may be done to avoid this).
In conclusion, before you make a decision about what you should do with an IRA left to you by a surviving spouse, be sure to consider the following: when you would like to receive this income, how you want to hold the investment and the what tax implications of your decision will be. A tax and finance attorney or financial advisor will help ensure you make the best decision for preserving this hard earned asset.
IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with Treasury Department Regulations, we inform you that any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used for the purpose of (i) avoiding penalties that may be imposed under the U.S. Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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