Inheriting an IRA account can be a complicated process that if not properly planned for and handled in the correct way can result in a great deal of unwanted stress and even a larger than expected tax liability. In this two-part blog series, we will explore the top strategies to consider when inheriting an IRA as a spouse (in this post) and strategies and considerations as a non-spouse benefactor and beneficiary (in the next post).
Inheriting an IRA from Your Spouse
While there are a few options that can be made, let’s focus our attention on the two most common options – rolling the deceased spouse’s IRA into the surviving spouse’s IRA or keeping the IRA in the account with no transfer initiated.
First, rolling the deceased spouse’s Traditional IRA into the surviving spouse’s IRA (thus, making it one account) is typically recommended to surviving spouses who are younger than the deceased. Using a very general example, let’s say that John is age 72 when he passes away and his wife, Jane, is 65. Because John was past the age of 70 ½, he was required by the IRS to take his required minimum distributions (RMD) from his Traditional IRA (which was based on his average life expectancy). With it being 5 ½ years before Jane is obligated to take her required minimum distributions, after John’s RMD is taken, she can roll over the net proceeds of John’s IRA into her IRA. The deferred money will grow without having to take required minimum distributions and pay tax until she reaches the age of 70 ½. It also goes without saying that this strategy could potentially put Jane in a better situation for some good financial and tax planning given the chance there will be a lower tax liability.
Now let’s say that John is 75 and Jane is 71. Since required minimum distributions are based on average life expectancy it would still make sense for Jane to rollover John’s IRA into her IRA given the fact that she has a longer life expectancy and smaller required minimum distribution divisor based on her age.
On the other side of that, let’s say that John is 65 and Jane is 72 when he passes away. Jane can keep John’s Traditional IRA open and defer the required minimum distributions until he would have reached age 70 ½. This again is a way to lower a tax liability – especially if one spouse’s IRA is significantly more than the other.
Another situation where it may be best to keep the IRA accounts as two separate accounts is when the surviving spouse needs income and is younger than the age of 59 ½. Using John and Jane as examples again, let’s say that Jane is 55 and is in need of income for whatever reason. If she took John’s IRA and rolled it into her IRA, and then took a distribution to supplement her lifestyle, she would have to pay tax on the amount in which she withdrew plus a 10% excise tax on an early withdrawal because she has not reached age 59 ½. If she was to keep the two IRA accounts separate and withdrew from John’s account, she would still have to pay tax on the amount from which she withdrew, but there would not be a tax penalty for an early withdrawal if it came from John’s account.
In cases where the surviving spouse had a Roth IRA, more times than not the recommendation would be to take the Roth IRA and roll it into the surviving spouse’s Roth IRA due to the fact that the Roth has after-tax monies that are able to be distributed tax free.
In closing, the death of a spouse can be a life altering event and the added financial stress of not properly establishing the right direction of the IRA accounts can add even more stress. If you find yourself in this situation, we recommend that you first discuss everything with your financial planner or tax advisor to ensure you are indeed taking the right strategy tailored to your needs.
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