In my last post I wrote about inherited IRAs for non-spouse beneficiaries; for example, if you inherit an IRA from a parent or sibling. Most often, IRAs will pass from an IRA owner to their surviving spouse before they pass to a non-spouse beneficiary like their children.
The rules regarding spousal IRAs are different. When you inherit an IRA from your husband or wife there is one key decision you must make that could affect your ability to access funds in that IRA for years to come.
Should you combine your deceased spouse’s IRA with your own?
When a surviving spouse inherits an IRA from their deceased husband or wife they have a choice to make. They can choose to combine the inherited IRA into their own or they may set up a separately titled, inherited, spousal IRA.
Distributions from IRAs always count toward your taxable income in the year of the distribution. But if you are under the age of 59 ½ there may also be a 10% penalty on any money taken out of the IRA.
With a separately titled, inherited, spousal IRA the surviving spouse may take distributions from the IRA without paying a penalty even when they are under the age of 59 ½. This provides a surviving spouse with greater liquidity and access to money during a time in which she may need it most. That’s the key benefit of an inherited, spousal IRA.
However, if the inherited IRA is merged with the surviving spouse’s IRA, the IRS will treat the entire IRA as if it belonged to the surviving spouse all along, making it more difficult for a widow or widower to access funds inside their deceased husband or wife’s IRA account. If she is under age 59 ½ when she takes distributions from this IRA, the IRS will assess a 10% early distribution penalty.
If you are over age 59 ½
If you inherit your spouse’s IRA and you are over age 59 ½, it doesn’t matter if the IRA is in your name or if it is a separately titled spousal IRA – at least as far as the 10% penalty goes. There is never a penalty on IRA distributions after age 59 ½, and distributions at any age are taxable.
Normally when you inherit an IRA from a parent, a sibling or anyone other than your spouse, the IRS requires the owner of the inherited IRA to take a Required Minimum Distribution (RMD) each year. This RMD is based on the account balance as of December 31 of the previous year and your age at the time you inherited the IRA.
When you inherit an IRA from a spouse, the RMD calculation is different. If you set up a separately titled, spousal IRA, the IRA RMDs begin when the original IRA owner would have turned 70 ½ .
If you combined the IRA with your own, the RMD’s start when you turn 70 ½ (or more accurately, April 1 of the year after the year you turn 70 ½).
All of the above assumes that your deceased spouse was under age 70 ½ at the time they died and had not yet begun taking their IRA RMD. If they were over age 70 ½ and they have been taking their IRA RMD, future RMDs are based on the longer of your life expectancy or that of your deceased spouse.
To calculate the RMD on an IRA, click here.
IRA distribution planning
IRAs and IRA distribution planning can be complicated. Making a mistake can have serious tax consequences.
The right IRA distribution plan depends on whether an IRA is passed to a spouse or a non-spouse beneficiary, the age of the original IRA owner, and the age of the beneficiary and other factors.
If you inherit an IRA or have IRAs and other retirement plans that will pass to a beneficiary in the future, consult with your financial advisor or tax professional to determine the best plan for you.