Inheriting An IRA From Your Spouse: How Understanding The Rules Can Avoid Major Mistakes

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If you are the spouse of an IRA owner who has named you as their beneficiary, it is critical that you—and the owner of the IRA—understand the rules that govern IRA inheritances. Not understanding the rules could result in paying higher taxes or penalties and forfeiting the opportunity for future U.S. tax-advantaged growth. Unfortunately, the rules are not simple, particularly when compared to the rules for when a child or other non-spouse beneficiary inherits the same account. In this article we address options for American spouses who are the sole beneficiary of their spouse’s IRA. We will address issues and options for Bermudian spouses (who are not dual nationals of Bermuda and the United States or US green card holders), and other situations, in future guides.

First, it is important to know that the IRS requires an IRA owner to take required minimum distributions (RMDs), which now generally begin at age 731. The previous age for RMDs was 72. So, if you or your spouse turned age 72 in 2022 and had already begun taking RMDs, you and your spouse should generally continue to take your RMDs. These RMD rules also apply to an inherited IRA.

If you are the spouse of an IRA owner, you generally have several options to consider and each option depends on your goals and objectives, as well as your facts and circumstances.

1. Transfer The Assets Into A New Or Existing IRA In Your Own Name

As a surviving spouse, you have the unique option to roll the assets held in your spouse’s IRA into an IRA in your name, thus treating those assets as if they were your own. This is sometimes referred to as a “spousal rollover”. This is an irrevocable decision. Once the funds are deposited into your own IRA, they are treated as if they had always been in the account. There is no way to change the action taken and be treated as a beneficiary once again.

This option may be a good choice if you don't have an immediate need to tap into your spouse's IRA assets and you are looking to keep the money in a tax-advantaged account for as long as possible. If you have not reached age 73 (or 75), but your spouse had, this option enables you to delay taking distributions until you reach age 73 (or 75) rather than continuing your spouse's RMDs.

Additionally, should your spouse have already begun taking RMDs but not taken the required amount before their passing, you will need to take the RMD for the current year.

However, if you are under age 59½ and you do need to access some or all of the assets you inherit from a traditional IRA, you will be subject to a 10% early withdrawal penalty.2 if you roll those assets into your own IRA and then take a distribution. If you find yourself in this situation, consider option 2, explained below.

If you choose to roll over or transfer the inherited IRA assets to your own IRA, the rules for RMDs will still apply. This means you must withdraw a certain amount of money from your IRA each year starting in the year you turn 73.

Distributions from a traditional IRA will generally be taxed as ordinary income. However, if the original account was a Roth IRA and the assets were in the account for 5 years or more, distributions may be tax-free. In either case, the registration type of both IRAs must match in order to transfer the assets from one account to another (e.g., traditional IRA to traditional IRA or Roth IRA to Roth IRA). If the assets were not in your spouse's Roth IRA for more than 5 years, it would be best to consult a professional regarding how withdrawals may be taxed, and whether it's best to roll them into your own Roth IRA or keep them separate in an inherited Roth IRA.

2. Establish An Inherited IRA

Similar to the way a non-spouse beneficiary does, you may move assets to an inherited IRA.

This option may make the most sense if you are under age 59½ and need to access some or all of your spouse's IRA assets now, or before you attain the age of 59½. This is the case because you won't be subject to a 10% penalty when you take withdrawals from an inherited IRA prior to age 59½ as you would be if you were withdrawing assets from a non-inherited IRA you may own. Once you reach age 59½, or no longer need to use those assets, you might consider transferring the inherited assets into your own IRA, as mentioned above.

Unlike other beneficiaries, who must typically begin taking RMDs from an inherited IRA by December 31 of the year after the IRA owner dies, a surviving spouse generally can begin taking RMDs in the year after the year of death, or you can delay beginning RMDs until your spouse would have turned age 73 or 75 (the same age RMDs need to begin). This is good to know if you were older than your spouse. Once you reach the year that your spouse would have turned age 73 or 75, depending on birth year, you may also want to consider transferring the inherited assets into your own IRA.

Example: Tom, age 40, is married to Janice, age 38. Tom, who has named Janice as his IRA beneficiary, dies unexpectedly. If Janice establishes a properly titled inherited IRA and continues to remain what is known as an "eligible designated beneficiary" of that account, she will not have to begin taking RMDs until the year Tom would have been 75. Therefore, even though Janice would be a beneficiary and have an inherited IRA, she would not have an RMD from that account for 30 years.

As long as your spouse was under age 73 when they died, you can withdraw inherited assets from an inherited IRA at any time, as long as the amount meets or exceeds the amount you are required to withdraw as a beneficiary. However, keep in mind that these larger distributions could push you into a higher tax bracket.

If you inherit a Roth IRA and transfer the assets to an inherited Roth IRA, your RMDs will always be treated as if your spouse were under age 73. Unlike Roth IRAs owned by the original owner, inherited Roth IRAs do require annual RMDs. You have the option to postpone these mandatory RMDs until the later of: the year in which the decedent would have attained age 73 or December 31st of the year following the year of death. Withdrawals from inherited Roth IRAs are normally tax-free as long as the original Roth IRA was funded for 5 years or more and any assets withdrawn from converted balances have also been in the account for at least 5 years.

If you decide to establish an inherited IRA, be sure your IRA custodian registers the account properly. The account registration should include the name of the person you inherited from, an indication that the account is an IRA beneficiary distribution account, and your name, as the inheritor. Note that different IRA custodians may have varying interpretations of the IRS's rules regarding account registrations.

3. Elect To Treat The Deceased Spouse's IRA As Your Own

You also have the ability to treat your spouse’s IRA as your own. When this option is used, you are effectively pretending that your deceased spouse’s account is your own IRA account.

Beginning in 2024, this election allows you to delay RMDs until your deceased spouse would have reached the age which their RMDs begin, and if you were to die before RMDs begin, your beneficiaries will be treated as though they were the original beneficiary of the account. In addition, once RMDs are necessary (e.g. in the year your deceased spouse would have reached their RMD age), you calculate RMDs using the Uniform Lifetime Table that applies to IRA owners rather than the Single Life Table that applies to beneficiaries, and generates larger RMDs.

This last benefit is entirely new and presents a planning opportunity for older spouses who inherit from younger spouses.

If timely action is not taken, it’s possible for you to end up automatically being treated as if you had elected to treat the inherited IRA as your own. For example, if you don’t take an RMD that you were supposed to take as a beneficiary, then you are deemed to be treating the IRA as your own.

4. Roll Over The IRA Assets Into A New Or Existing IRA And Then Convert The Assets To A Roth IRA3

If you don't anticipate needing to rely on RMDs from your spouse's IRA to pay your living expenses, you may want to consider rolling over the assets into an IRA in your name (option 1, above) and then converting the assets into a Roth IRA. This assumes that the IRA you inherited is a traditional IRA and not already a Roth IRA.

Unlike withdrawals, there are no penalties for conversions prior to age 59½; however, you will have to pay taxes on the amount of money you convert from your traditional IRA into a Roth IRA.

Therefore, converting to a Roth IRA may make sense for people who anticipate being in a higher tax bracket in the future and who have assets in a nonretirement account to pay the income tax associated with the amount converted to a Roth IRA. Ideally the taxes associated with the conversion should be covered with taxable assets rather than tax-deferred or exempt assets; otherwise, the amount used to cover the associated taxes will be considered a withdrawal and may be subject to penalties if below age 59½.

5. Disclaim (Decline To Inherit) All Or Part Of The Assets

While listed last, this option may need to be the first thing to evaluate, and legal counsel should be sought before taking action. A disclaimer is a legal refusal to accept an inheritance or gift, and may be considered not qualified or qualified, must be made within 9 months of your spouse’s death and before you take possession of the assets, and is irrevocable.

If you choose this option, the IRA assets will pass to either the remaining primary beneficiaries (if you are not the sole primary beneficiary designated) or to the contingent beneficiaries named by your spouse. This could be your children or grandchildren, another relative, a trust, or a charity.

When assets pass directly to the IRA owner's children or grandchildren, the potential for tax-deferred (or tax-free) growth may be limited to a 10-year period (for an account owner who died after January 1, 2020) except for certain non-spouse beneficiaries. A minor child of the account holder, a chronically ill or disabled spouse, or individual that is less than 10 years younger than the account holder can stretch their RMDs over their life expectancy.

In some cases, disclaiming IRA assets can be a smart estate-planning move, especially if your spouse's estate was not structured properly or facts and circumstances have changed. While assets you inherit from your spouse are generally not subject to estate taxes, they do become part of your estate when you die.

If you think that the inclusion of inherited IRA assets will cause the total amount of your estate to exceed the estate tax exemption limit for married couples, disclaiming all or a portion of your spouse's IRA could make sense. Note that a decision to disclaim assets must be made within 9 months of your spouse's death and before you take possession of the assets.

By pro-actively understanding the key issues and opportunities you can reduce the risk of post-death mistakes.

Need some help navigating your options? Patterson Partners is here for you. We work with American expats and cross-border families to help them maximize their life+wealth and avoid costly mistakes, particularly when it comes to minimizing your lifetime tax bill. We understand the complex interaction of US and Bermuda tax and regulatory regimes and take account currency, diversification and other portfolio considerations as we help build and implement custom strategies to meet your specific needs. Learn more about our process for becoming a client here. Not ready for help? Check out our founder’s book, Financial Planning for Global Living.

[1] You are always able to take money from your IRA. Some withdrawals may be taxable, and some may be subject to a 10% early withdrawal penalty. If you are over age 59½, you aren't subject to a 10% early withdrawal penalty.
[2] The change in the RMDs age requirement from 72 to 73 applies only to individuals who turn 72 on or after January 1, 2023. After you reach age 73, the IRS generally requires you to withdraw an RMD annually from your tax-advantaged retirement accounts (excluding Roth IRAs, and Roth accounts in employer retirement plan accounts starting in 2024). Please speak with your tax advisor regarding the impact of this change on future RMDs.
[3] For a distribution from a Roth IRA to be considered qualified, the 5-year aging requirement has to be satisfied, and you must be age 59½ or older or meet one of several exemptions (disability, qualified first-time home purchase, or death among them).
This information is for general information and educational purposes and should not be considered legal, tax or investment advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Patterson Partners Ltd. cannot guarantee that the information herein is accurate, complete, or timely. Patterson Partners Ltd. makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
Recently enacted legislation in the United States made a number of changes to the rules regarding defined contribution, defined benefit, and/or individual retirement plans and 529 plans. Information herein may refer to or be based on certain rules in effect prior to this legislation and current rules may differ. As always, before making any decisions about your retirement planning or withdrawals, you should consult with qualified professionals.

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