Inheriting a Spouse's IRA

When a spouse dies, the survivor is often forced to make a number of financial decisions. If no plan is in place, some of the decisions may be uncomfortable. Worse, making a mistake can result in tax penalties, lost value, and a potentially higher tax burden.

Even though the IRS issued rules in 2001 that make it easier for a surviving spouse to inherit an IRA, it is still critical to make knowledgeable decisions because they could have far-reaching consequences. Consider what can happen to an IRA left to a spouse as sole beneficiary.¹

Two Options to Consider
Leave the account in the deceased spouse's name. With this option, you are still required to take minimum distributions (either based on your single life expectancy or the year in which the IRA owner would have reached age 70½). Failing to take required minimum distributions could result in a penalty of 50 percent of the amount you should have withdrawn. Of course, if you don't change the account ownership to your name, the beneficiary of the account will be the contingent second beneficiary designated by the deceased spouse, not necessarily someone you name.

Transfer the account to your name. If you're under age 70½ when you inherit an IRA, you can wait to begin taking required withdrawals, which would let the funds accumulate tax deferred for a longer time. If you're over age 70½, you can calculate the minimum withdrawals based on your own life expectancy. If you are younger than your spouse, the minimum distributions would be lower, which could result in lower taxes. As the account owner, you can also name your own beneficiary. 

Something Else to Consider
A Roth IRA is generally much easier to inherit than a traditional IRA. No minimum withdrawals are required during the survivor's lifetime as long as the account is transferred into the survivor's name. This allows the funds potentially to be stretched out over a longer period and significantly eliminates the possibility of penalties. Married couples may want to consider converting their traditional IRA to a Roth IRA because of the flexibility it offers. Of course, remember that ordinary income taxes are due on the amount converted from a traditional IRA to a Roth IRA in the year that the transaction is made.

Surviving spouses have to make many tough decisions. Planning ahead may help you avoid making the wrong one. 

1) Distributions from traditional IRAs are taxed as ordinary income and, if taken prior to reaching age 59½, may be subject to an additional 10 percent federal income tax penalty. Withdrawals must begin by April 1 of the year after the year in which you reach age 70½.
2) To qualify for the tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59½ or due to death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum).

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