Spousal Rollover IRA
Losing a spouse is a devastating event, and adjusting to an altered life while dealing with all the financial decisions can be overwhelming. If your spouse had an IRA, one of the financial decisions you'll have to make is deciding how you want to treat it when you inherit it. If you inherited an IRA from someone other than a spouse a different set of rules apply.
If You Inherited a Traditional IRA From Your Spouse
There are two primary types of IRAs you can inherit a traditional IRA or a Roth IRA. If you inherit a traditional IRA from your spouse, you have three primary choices. The rules for Roth IRAs are different.
You Can Cash It In
You'll pay income taxes on the amount withdrawn when you cash in the IRA, but no penalty taxes will apply regardless of your age. This is a good thing because normally IRA distributions prior to age 59 1/2 are subject to a 10-percent early IRA withdrawal penalty tax.
But even taking penalty taxes off the table, cashing in the IRA might not be your best choice. You have to consider your tax bracket. Cashing in a large IRA could mean that anywhere from 25 percent to 39.6 percent of it goes straight to federal taxes. State income taxes will apply, too. You may be better off withdrawing money as you need it instead of cashing in the entire inherited IRA all at once.
You Can Treat the IRA as Your Own
You can treat the IRA as your own by naming yourself as the account owner or by rolling the inherited IRA into your own IRA account. This can often be your best choice if you're over age 59 1/2 and/or your spouse was older than you.
It allows you to delay taking required minimum distributions, called RMDs, as long as possible. If you choose to treat the IRA as your own, your future RMDs will be determined based on your own age beginning with the year you become the owner.
Here's an example: Your spouse was 72. You are age 65. Your spouse started taking his RMDs at age 70 1/2. You elect to treat the inherited IRA as your own. You don't have to take annual RMDs until you reach age 70 1/2 regardless of the fact that your spouse was doing so. The clock effectively resets.
The advantage in this is continued tax deferral. Keep in mind that if you are over age 59 1/2, you can still take withdrawals if you need the money and no penalty tax will apply. You're just not required to do so until you reach age 70 1/2.
But here's a word of warning: If you're not yet 59 1/2 and you choose to treat the IRA as your own, your distributions will be subject to a 10-percent penalty tax.
You Can Treat Yourself as the Beneficiary
This may be your best choice if you're under age 59 1/2 and/or you're older than your spouse. When you set the account up so you're considered the beneficiary of the inherited IRA instead of the owner, your required minimum distributions are determined by your spouse's age at the time of his death. This presents two possibilities.
If your spouse died after his RMDs began because he was over age 70 1/2, you must take distributions based on the longer of:
- Your deceased spouse’s life expectancy based on his previous RMD schedule
- Your own single life expectancy
If your spouse died before his RMDs began, you can defer distributions until his RMDs would have started and take distributions then over your single life expectancy.
The advantage of this choice is that you can take withdrawals if necessary and no penalty tax will apply if you're not yet 59 1/2. And if you're older than your spouse, you can defer the RMDs until your spouse would have been required to take them, which will be a later date than your own age 70 1/2.
NOTE: Nothing in this article is intended as advice. It is important to carefully weigh your options based on your cash flow needs and your tax situation, ideally after consulting with a financial professional.