Inheriting a Traditional IRA from a Spouse

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“This Post Has Not Been Updated to Include Changes from the “Tax Cuts and Job Act” passed on December 22, 2017.”

Wealth transfers in the next few decades will be the greatest in history. Beneficiaries who receive individual retirement accounts (IRAs) from family members could see windfalls that require strategic tax planning.

You should always get professional advice before cashing out any IRA. If you’ve inherited an IRA, you have several options for handling the assets, and different rules apply to you if you’ve inherited a traditional IRA from your spouse.

Which option is best for you will depend on your age, the age at which your spouse died, and your expected income vs. expenses in the near and long term. 

 

Consider the following four options for handling funds inherited in a traditional IRA.

 

1. Roll the assets into an IRA in your name.

You can treat the IRA as your own, rolling the money into an account under your name. This will allow you to keep the money in a tax-advantaged account until you reach the age of 70½, when you will have to begin taking required minimum distributions (RMDs). If you fail to take a RMD, you may be subject to a steep penalty–50% of the RMD amount that you fail to withdraw. On the other hand, if you access the funds in this account earlier than age 59½, you’ll be subject to a 10% early withdrawal penalty.

 

2. Transfer the assets to an inherited IRA.

If you are under the age of 59½, this option will allow you to access to the money in the IRA without paying the 10% penalty. Once you reach age 59½, you will be able to transfer the assets to your own IRA. If you are older than your spouse, this option will also allow you to delay taking RMDs until your spouse would have turned 70½.

An inherited IRA also allows you to use the five-year rule. Under this rule, you can put off withdrawing funds from the account for five years if your spouse was under the age of 70½ at time of death. Then, the assets must be withdrawn no later than Dec. 31 on the fifth year following your spouse’s death. Bear in mind, however, that cashing out a substantial IRA could push you into a higher tax bracket in the year you withdraw the funds.

If you choose an inherited IRA, be sure the custodian registers it properly and includes the name of the deceased in the registration.

 

3. Roll the assets into an IRA in your name, and then convert to Roth.

If you don’t need the income from the IRA right away, consider rolling the assets to your name (Option 1), and then converting the traditional IRA to a Roth IRA. This will require you to pay taxes on the amount you convert. However, if you anticipate being in a higher tax bracket in the future—when you will be taking RMDs—this option may reduce your overall tax obligation.

 

4. Decline to inherit the IRA.

If you decline to inherit the IRA (either in part or fully), the assets will go to the account’s contingent beneficiaries. As non-spouses of the original account holder, these alternative beneficiaries will be subject to different IRA inheritance rules.

If you think the total amount of your estate will exceed the estate tax exemption limit, declining to inherit may be your best option. To take advantage of this option, you must decline the inheritance in writing within nine months of your spouse’s death. This decision is irrevocable.

 

Additional Tips

Frequently revisit your and your spouse’s beneficiaries to ensure they remain current. As life happens, beneficiaries often change due to events such as deaths, divorces, marriages, and births.

When rolling over your IRA, be sure to use a trustee-to-trustee transfer. If a check is sent from the custodian of the IRA, there could be tax issues because non-spousal IRAs are not eligible for 60-day rollover. This type of check is taxed as ordinary income and will not be eligible to be deposited back to an inherited IRA.

Commingling inherited IRAs is not permitted. If you inherit IRAs from different people, you may put them into a single IRA.

Please discuss your options with your tax advisor before deciding how to treat an IRA that you’ve inherited. Selecting the wrong option could add substantial costs to your tax bill.

 

The experts at AgriSolutions can help you get the most out of your income with farm accounting and tax services, consultation, and training. Click the link below to get a free review of your tax return to make sure you’re taking advantage of all the deductions and exemptions available to you.

Free tax return review

 

Descriptions provided in this article are presented as generalities. There are many factors not listed above which may impact your options. This article should not be considered legal or tax advice. For advice on a specific transaction, please contact the AgriSolutions Tax department at taxes@agrisolutions.com.

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