Spousal inherited IRA’s have flexible benefits for the surviving spouse – if they understand the rules of the game.

Under most circumstances a married person will put their spouse as the primary beneficiary on their IRA accounts. The IRS has different rules about how different types of beneficiaries must distribute the IRA they inherit. And if the IRA beneficiary does not follow the rules there can be some big penalties.

Luckily, the IRS gives the most flexibility to a person that inherits an IRA from their late spouse.

But which option the surviving spouse needs to choose can depend on a lot of different factors. Let’s discuss the rules, who needs to know the rules, and how they actually work.

If you’re married and have an IRA, you need to understand this

It’s good for all married people that have listed their spouse as the primary beneficiary (or are listed as the primary beneficiary) on their IRA to have a basic understanding of how the rules work.

Even if both you and your spouse are healthy and you think there is no need to know this.

That’s because even if you are both healthy it’s good to prepare for the unexpected, to have contingencies in place. And to know if something tragic were to happen, the surviving spouse would know what their options are going forward.

The basic inherited IRA rules for spouses

A surviving spouse that is listed as the primary beneficiary on their late spouse’s IRA generally have three choices they can make.

  1. They can designate themselves as the account owner of the IRA.
  2. They can roll it over into their own IRA or into their qualified employer plan, like a 401k
  3. Or treat themselves as the beneficiary of the IRA, instead of treating the IRA as their own.

A spouse has the option to treat the inherited IRA as if it were their own. No other type of beneficiary (such as children, grandchildren, etc.)  has that option.

This offers spouses much great flexibility with their choices going forward.

Treating the inherited IRA as your own

Of the 3 options listed above the first two of them are essentially treating the IRA as if it were you own. So let’s discuss that first.

The main thing to remember is that as a spouse if you elect to consider the inherited IRA as your own by naming yourself as the IRA holder, the funds will be subject to all the same rules that an IRA is subject to.

For instance, if you are under age 59.5 then any withdrawals you make from an IRA are under most circumstances subject to the 10% IRS penalty for early withdrawal. Even if your deceased spouse was older than 59.5 it doesn’t matter.

If you choose to treat your late spouse’s IRA as if you were the account holder, those funds become subject to regular IRA rules. This includes the 10% early withdrawal penalty.

Made Easy Example #1:

Mary is 53. Her husband is 60 and unexpectedly dies. Mary is the 100% beneficiary on his IRA. She elects to treat the IRA as her own, instead of treating it as a beneficiary IRA. When she goes to withdraw money from it, she finds out she has to pay the 10% early withdrawal penalty (in addition to regular taxes owed on IRA withdrawals). Even though her husband was over age 59.5, the fact that she chose to treat the IRA as her own means it will be subject to the regular IRA withdrawals, including the 10% penalty for early withdrawal before age 59.5.

You can see how this turns out to be a bad decision for Mary. If she knew she didn’t need the funds until later after she had reached the age of 59.5, then maybe treating the IRA as her own (and not as a beneficiary IRA) would have been the better choice.

How could she have avoided paying that 10% penalty?

Treat the IRA as a Beneficiary IRA

The other option for a spouse is to treat the IRA as a Beneficiary IRA. In the above example, if Mary had done that she would have been able to avoid the 10% penalty for pre-age 59.5 withdrawals.

There are still some rules that must be followed if a spouse treats themselves as the beneficiary of the IRA, as opposed to being the owner.

The biggest rule that must be followed is that required minimum distributions (RMDs) must be taken from the account.  The rules for these RMD’s are much more flexible for spouses than they are for most other beneficiaries. And in this article we’re just talking about the options available to surviving spouses.

A surviving spouse who treats themselves as the beneficiary of their late spouse’s IRA must take RMDs from this inherited account. The RMD’s can be based on the surviving spouse’s life expectancy.

So if the surviving spouse is younger than the late spouse, the RMDs will be lower and stretched out over a longer expected lifespan.

And, I know you’re thinking it, “Can the surviving spouse take out more than just the required minimum?”

And the answer is yes. And since they’ve treated themselves as a beneficiary (as opposed to owner of the IRA) the 10% early withdrawal penalty won’t apply even if they are under age 59.5.

As for WHEN the RMDs must begin for the surviving spouse, that is based on the age of the deceased spouse.

  • If the deceased spouse was over the RMD age at the time of their death, that is they were older than 72 at the time of their death, then the surviving spouse must begin taking RMDs by December 31st of the year following death. And keep in mind the late spouse’s RMD for the year they were still living has to be paid as well.
  • If the deceased spouse was under the RMD age at the time of their death, that is they were younger than 72 at the time of their death, then the surviving spouse must begin taking RMDs by December 31st of the year the late spouse would have turned 72.

Made Easy Example #2:

Mary is 55. Her husband was age 65 when he died. She treated herself as the beneficiary on the IRA she inherited from him. She doesn’t have to take RMDs from this inherited IRA for another 7 years. That’s because her husband wouldn’t have turned 72 until 7 more years had passed. Mary will take an RMD by December 31st of the year that her late husband would have been 72.

Let’s look at another example

Made Easy Example #3:

Mary is 55. Her husband was 73 when he died. She treated herself as the beneficiary on the IRA she inherited from him. Since her late husband was already over age 72 he was subject to RMDs. Therefore, Mary must make sure that he took out his RMD for the year he died. Then going forward she must take RMDs from this account, but now the RMDs are based on her younger age. Thus, the RMDs from this IRA go down as they are calculated on her longer expected lifespan. In addition, it bears repeating that since she treated herself as the beneficiary of this IRA (as opposed to naming herself the owner) she was not subject to the 10% early withdrawal penalty, even though she was under 59.5.

It’s good to note that in the above examples, if Mary had chosen to consider the IRA her own, as opposed to choosing it as a beneficiary IRA, she would not have had to take RMD’s until she reached age 72.

But on the flip side, if she had needed the funds immediately, she would have had to pay the 10% early withdrawal penalty because she was under age 59.5. By choosing to treat it as a beneficiary IRA she avoided the 10% penalty.

Conclusion: What should a spouse do with an inherited IRA?

The decision is different for everyone based on their age and needs. Here are some examples:

If the surviving spouse needs access to the inherited funds AND they are under age 59.5, it may make sense to treat themselves as the beneficiary of the IRA so they can avoid the 10% early withdrawal penalty.

If the surviving spouse is under age 59.5 and they don’t need access to the funds before turning 59.5, it may make sense to treat themselves as the owner of the IRA. If they don’t need the funds, they should avoid the 10% early withdrawal penalty. And any RMDs would be delayed until they turn 72. Whereas treating themselves as the beneficiary of the IRA, the RMDs will begin at the age their late spouse would have turned 72.

If the surviving spouse is older, they may want to treat themselves as the beneficiary of the IRA. That way, even when they turn 72 they won’t have to begin taking RMDs from the account until their younger deceased spouse would have turned 72. This would allow the surviving spouse to delay having to remove funds from the IRA a little bit longer.

For a lot of surviving spouses it may make sense to just treat themselves as the owner of the IRA. The reason is because the way statistics work out, typically the older spouse is going to die first, and there’s a good chance it will happen after both spouses are older than 59.5 years old.

Also, the average age difference of spouses is around 2-3 years. So the delaying of RMDs is not that big of a game changer.

However, it’s good to understand these rules. Especially for married couples where the age difference between the spouses is much larger, say on the 10-15 year range.

It’s also important for people to understand these rules if they would need access to the inherited IRA funds before they turn 59.5. Understanding this can help them avoid the 10% early withdrawal penalty.

Also, keep in mind, that once you make a decision to treat the inherited IRA as your own you can’t undo that decision. So weigh the options and seek good advice before making the decision.

Chris Hammond

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