Did you know that when you inherit an IRA you can limit your income tax liability by deciding how distributions are made to you? Unfortunately, many IRA beneficiaries don’t know they have distribution options and so they cash in their inherited IRA and expose themselves to significant income tax liabilities. The options available to IRA beneficiaries vary depending on if the beneficiary is a surviving spouse or a non-spouse and if the IRA is a traditional IRA or Roth IRA. This article will focus on the typical traditional IRA distribution options for a surviving spouse to limit the surviving spouse’s tax liabilities. Click here for options for non-spouse beneficiaries. Not all distribution options work best for every beneficiary, so beneficiaries are encouraged to consult with their financial advisor, CPA, and attorney to find out which option works best for them.
Option 1: Treat IRA as Own
One option surviving spouses have is treating the IRA as their own. Surviving spouses can treat inherited IRAs as their own by naming themselves as the account owner or by rolling the inherited IRA into their own IRA account. This is often the best choice if the deceased spouse was older than the surviving spouse because it allows the surviving spouse to delay taking the IRA’s Required Minimum Distributions (RMDs) until he or she reaches age 70½ rather than using the deceased spouse’s age. The benefits of this option are best described using an example: Husband dies at age 73 leaving his IRA to his wife who is age 62. Wife subsequently chooses to roll over the IRA into her own. Although Husband started taking his RMDs at age 70½, Wife is not required to take RMDs on the rollover IRA until she reaches age 70½. This choice effectively resets the IRA’s RMDs using the surviving spouse’s younger age and offers the surviving spouse additional years of tax-deferred growth.
Option 2: Leave Ownership in Deceased Spouse’s Name
The second option for a surviving spouse beneficiary is leaving ownership of the IRA in the deceased’s spouse’s name, for the benefit of the surviving spouse. This is often the best choice for a surviving spouse if the deceased spouse was younger than the surviving spouse. If the surviving spouse chooses this option, the RMDs are determined using the deceased spouse’s age at the time of death instead of the surviving spouse’s age, which presents two possibilities:
(1) if the deceased spouse died after age 70½: the RMDs must be taken on the longer of the deceased spouse’s life expectancy based on his/her previous RMD schedule or the surviving spouse’s life expectancy; or
(2) if the deceased spouse died before age 70½: the surviving spouse can defer RMDs until the deceased spouse would have been required to take them.
Keep in mind that in order for this option to work properly, ownership of the IRA must stay in the decedent-owner’s name, for the benefit of the surviving spouse beneficiary. If the surviving spouse has already transferred the IRA ownership into his or her name, the surviving spouse will not receive the advantages of using this option.
Option 3: Rollover IRA with 5 Year Distribution
Another option for a surviving spouse beneficiary is to rollover the IRA into their name and cash out the IRA within five years of December 31 of the year following the deceased spouse’s date of death. This option gives the surviving spouse access to money relatively soon and spreads out the tax liability over a five year period, rather than in one year if a lump sum distribution is taken.
Option 4: Lump Sum Distribution
A surviving spouse beneficiary also has the option to cash in the IRA and take a lump sum distribution; however, the spouse will be responsible for paying income taxes on the distribution in the year the distribution is made. This option gives the surviving spouse immediate access to money but can potentially subject the IRA income to higher tax rates.
The traditional IRA distribution rules and options for surviving spouse beneficiaries are complicated. If you are a surviving spouse and listed as the beneficiary of your deceased spouse’s IRA, meet with your CPA or tax attorney to decide what option will work the best minimize your taxes.
Bill Hesch is a CPA, PFS (Personal Financial Specialist), and attorney licensed in Ohio and Kentucky who helps clients with their financial and estate planning. He also practices elder law, corporate law, Medicaid planning, tax law, and probate in the Greater Cincinnati and Northern Kentucky areas. His practice area includes Hamilton County, Butler County, Warren County, and Clermont County in Ohio, and Campbell County, Kenton County, and Boone County in Kentucky.
(Legal Disclaimer: Bill Hesch submits this blog to provide general information about the firm and its services. Information in this blog is not intended as legal advice, and any person receiving information on this page should not act on it without consulting professional legal counsel. While at times Bill Hesch may render an opinion, Bill Hesch does not offer legal advice through this blog. Bill Hesch does not enter into an attorney-client relationship with any online reader via online contact.)