Inheriting an IRA from your spouse

If you are the spouse of an IRA holder who has named you as their beneficiary, it’s very important that you and the owner of the IRA understand the rules that revolve around IRA inheritances.

The IRS required IRA owners to take RMDs, generally starting in the year they turn 70 ½. RMD rules apply to an inherited IRA as well, and may even apply to those inherited by you as a spouse.

Your decision will be determined by your age, age of the spouse, your need for income based off of your inherited IRA assets, the type of IRA you inherit, and maybe, any creditor protection concerns. 

If you’re the spouse of an IRA owner, you probably have 4 options with respect to the disposition of inherited IRA assets:

1. Roll over the assets into a new or existing IRA in your own name

When you’re a surviving spouse, you have an option that nobody else has which is rolling inherited IRA assets into an IRA in your name and treating those assets as if they were yours. This can be a good choice if you don’t have an immediate need to tap into your spouse’s IRA assets and you’re looking to keep the money in a tax advantaged account for a long period of time. If you are not 70 ½ yet but your spouse is, this option lets you delay taking distributions until you reach 70 1/2 , rather than continuing your spouse’s RMDs.

If you’re under age 59 ½ and you need to access some or all of the assets you inherit from a traditional IRA, you will be exposed to a 10% early withdrawal penalty if you roll those assets into your own IRA and then take a distribution. If you’re in this situation, consider the options below.

If you choose to roll over the inherited IRA assets to your own IRA, the rules for RMDs still apply. You must withdraw a certain amount of money from your IRA, including inherited assets, each year until you reach the age of 70 ½. Your RMD amount will be calculated using your age to determine the life expectancy factor.

If your spouse was 70 ½ or older at the time of death, you’ll need to determine whether they met the RMD for the year in which they passed away. If your spouse didn’t meet the RMD, you have to take an RMD for that year by December 31. However, this distribution must be reported under your SSN. The year of death RMD will be calculated using your spouse’s age and life expectancy. If you don’t reach the December 31 deadline, you can be subject to an IRS penalty which can be 50% of the amount not withdrawn. For deaths that occur later in the year, you should file IRS Form 5329 with a letter that has an explanation that requests a waiver of the penalty if you missed the deadline.

Distributions from a traditional IRA will probably be taxed as ordinary income. However, if the original account was a Roth IRA and the assets were in the account for 5 or more years, distributions may be tax-free. The registration type of both IRAs must match in order to transfer the assets from one account to another. If the assets weren’t in your spouse’s Roth IRA for more than 5 years, it would be best to get in contact with a tax advisor on how withdrawals may be taxed, and whether it’s best to roll them into your own Roth IRA or seperate them to an inherited Roth IRA.

2. Transfer the assets to an inherited IRA

Transferring assets to an inherited IRA may make the most sense if you’re under age 59 ½ and you need to access your spouse’s IRA assets now, or before you attain the age of 59 ½. This is a good idea because you won’t be subject to a 10% penalty when you take withdrawals from an inherited IRA prior to age 59 ½ as you would if you were withdrawing assets from a non-inherited IRA you may own. Once you’re 59 1/2 , or no longer need to use those assets, you may consider the inherited assets into your own IRA.

Spouse inheritors also have more rules regarding the RMD timing for inherited IRAs. You can start taking RMDs in the year after the year of death, or you can delay beginning RMDs until your spouse would have turned age 70 ½. This is great to know if you were older than your spouse. The RMD amounts are based on the IRS Uniform Lifetime Table, your spouse’s age. Once you are in the year that your spouse would have turned age 70 ½, you may want to consider transferring the inherited assets into your own IRA.

Another option is to use the 5-year rule. As long as your spouse was under the age of 70 ½ when they died, you have 5 years of which you can withdraw inherited assets from an inherited IRA at any time and amount, as long as the assets are withdrawn by December 31 of the 5th year following your spouse’s death. Keep in mind that these larger distributions can push you into a higher tax bracket.

If you inherit a Roth IRA and transfer the assets into an inherited Roth IRA, your RMDs will be treated as if your spouse were under the age of 70 ½. Inherited IRAs require annual RMDs, and you must begin RMDs by December 31 of the year following your spouse’s death. The RMDs will be based on the Single Life Expectancy Table. You also may elect to take distributions under the 5-year rule. Withdrawals from inherited Roth IRAs are normally tax-free as long as the original Roth IRA was funded for 5 years or more.

If you choose to establish an inherited IRA, make sure your IRA custodian registers the account properly. The account registration should include the name of the person you inherited from, an indication that the account is an IRA beneficiary distribution account, and your name, as the inheritor. 

3. Roll over the IRA assets into another new/existing IRA and convert the assets to a Roth IRA

If you don’t plan to need to rely on RMDs from your spouse’s IRA to pay your living expenses, you might want to roll over the assets into an IRA in your name and then convert the assets into a Roth IRA. This assumes that the IRA you inherited is a traditional IRA and not already a Roth IRA.

Contributions with a Roth IRA aren’t tax deductible, but you pay no tax when you withdraw assets, when certain conditions are met. You will have to pay taxes on the amount of money you convert from your traditional IRA into a Roth IRA. Therefore, converting to a Roth IRA makes more sense for people who anticipate being in a higher tax bracket in the future and who have assets in a non-retirement account to pay the income tax associated with the amount converted to a Roth IRA. Generally the taxes associated with the conversion should be covered with taxable assets rather than tax-deferred/exempt assets.

4. Disclaim all or part of the assets

If you’re going with this option, the IRA assets will pass to your spouse’s contingent beneficiaries.

When assets pass directly to the IRA owner’s children or grandchildren, the potential for tax-deferred (or free) growth will be spread out over a much longer time period. Though the children or grandchildren will need to begin taking RMDs in the year after the IRA’s owner’s death, the RMD calculation will be based on the life expectancies of these younger inheritors.

In some cases, disclaiming IRA assets can be a good estate-planning move, especially if your spouse’s estate wasn’t structured enough. While assets you inherit from your spouse are mainly not subject to estate taxes, they do become part of your estate when you die. Make sure to consult a tax professional or attorney.

If you think that the insertion of inherited IRA assets will cause the total amount of your estate to exceed the estate tax exemption limit for married couples, disclaiming a portion or all of your spouse’s IRA could be smart. You should know that a decision to disclaim assets must be made within 9 months of your spouse’s death and before you take possession of the assets. This is an irrevocable decision. It’s critical that you consult a tax advisor or attorney before disclaiming IRA assets.