Beneficiary Spouses Face Important IRA Decisions

September 2, 2014

Most husbands and wives name their spouse as the primary beneficiary of their IRA. What does a surviving spouse need to consider as the beneficiary?

Like any other beneficiary of a decedent’s IRA, a surviving spouse can receive a distribution as a beneficiary. But a surviving spouse who is the sole beneficiary of the decedent’s IRA has two additional favorable options that are not available to other beneficiaries.

The surviving spouse may:

• Elect to treat the decedent’s IRA as the surviving spouse’s own IRA; or
• Roll over the decedent’s IRA into an IRA established in the spouse’s name.

In either case, the surviving spouse is treated as if he or she had funded the IRA.

Making the spousal election or rollover has three major advantages:

1. Required distributions may be delayed. With the rollover or the election, required distributions must begin no later than April 1 of the year following the year in which the surviving spouse attains age 70 1/2.

By comparison, if the IRA remains in the decedent’s name and the decedent’s death occurred:

• Before lifetime distributions commenced, then lifetime distributions to the spouse generally must begin by the later of (1) Dec. 31 of the year following the year in which the decedent died, or (2) Dec. 31 of the year in which the decedent would have attained age 70 1/2 had he or she lived.
• After required distributions began, payouts to the spouse-beneficiary must begin in the year following the IRA owner’s death.

Thus, a surviving spouse who is younger than the decedent can defer the start of the payout period by making the rollover or electing to treat the decedent’s IRA as the spouse’s own IRA.

2. Distribution period may be extended. Normally, a beneficiary’s required minimum distribution (RMD) is based on that beneficiary’s single life expectancy. With a spousal rollover or an election, the IRA is treated as if the surviving spouse had funded it. In that case, the spouse can take RMDs using the favorable Uniform Lifetime Table, which is based on the joint life expectancy of the spouse and a hypothetical 10-years-younger beneficiary. Note that a separate lifetime distribution table applies if the spouse was more than 10 years younger than the IRA owner.

3. Surviving spouse can name own beneficiaries. By naming new, younger beneficiaries after the rollover or the election, the surviving spouse may be able to extend the IRA payout period. Otherwise, when the surviving spouse dies, the balance remaining in the first decedent’s IRA will be distributed over what remains of the payout period that applied when the surviving spouse began receiving RMDs.

There is a potential tax issue for surviving spouses who are under age 59 1/2. Once the spouse elects to roll over the decedent’s IRA into the spouse’s own IRA, pre-age-59-1/2 withdrawals from that IRA generally will be subject to the 10 percent early distribution penalty tax on top of regular income taxes – unless an exception applies.

To avoid this problem, the surviving spouse could keep the entire IRA balance in the decedent’s name until the spouse reaches age 59 1/2. Any withdrawals before that age will be penalty-tax-free. The regulations provide that a surviving spouse-beneficiary’s election can be made “any time after the individual’s date of death.”