Spousal Rollover IRA

an older woman reading documents pertaining to her deceased spouse's IRA.
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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 individual retirement account (IRA) from someone other than a spouse a different set of rules will 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 which include cashing the account in, transferring it to your own account, or being a beneficiary. The Internal Revenue Service has specific rules for each situation. Also, the rules for Roth IRAs are different from traditional IRAs.

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You'll pay income taxes on the amount withdrawn when you cash in the IRA, but no penalty taxes will apply regardless of your age.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 59½, are subject to a 10% 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% to 39.6% 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 59½ or your spouse was older than you. If you plan to roll the account, be sure to let the processor of the inherited account know the exact name of the account you are sending the money to. If you touch the check, even if just to deposit it, you may face tax penalties.

Rolling the funds allow you to delay taking required minimum distributions (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 their RMDs at age 70½. You elect to treat the inherited IRA as your own. You don't have to take annual RMDs until you reach age 70½ 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 59½, you can still make withdrawals if you need the money and no penalty tax will apply. You're just not required to do so until you reach age 70½.

However, here's a word of warning: If you're not yet 59½ and you choose to treat the IRA as your own, your distributions will be subject to a 10% penalty tax. 

You Can Treat Yourself as the Beneficiary 

This can be your best choice if you're under the age of 59½ 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 their RMDs began because they were over age 70½, 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 their RMDs began, you can defer distributions until their 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 59½. 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 70½.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.