Posted by Stacey Snyder
Inheriting a retirement account, whether in a qualified plan or an IRA, can lead to complicated decisions regarding the treatment of the account. There are many different considerations that affect the beneficiary’s options. A spousal beneficiary has two options when it comes to an inherited retirement account: the spouse can either (1) keep the IRA under the deceased spouse’s name with the surviving spouse remaining as the beneficiary, or (2) make an affirmative election to treat the inherited account as his/her own. The benefits of each option vary, so the beneficiary must choose the option which best fits his/her particular circumstances. A non-spousal beneficiary, however, does not have the option to treat the Inherited IRA as his or hers, but can treat it only as an Inherited IRA.
Spousal Beneficiary Option 1:
The first option a spouse has when inheriting a retirement account is to keep the account under the deceased spouse’s name and remain as the beneficiary. If the inherited account is an employer-sponsored plan account, the spousal beneficiary may choose to roll over the account into a separate IRA. The terms of the plan may allow the spousal beneficiary to keep the funds in the plan and take lifetime distributions, but many plans require that the funds be distributed from the plan within 5 years following the year of the deceased spouse’s death. Since the account is still considered to be the deceased spouse’s, contributions may not be made into the retirement account and required minimum distributions (RMD) will be required as they would if the spouse were alive. The RMD will begin when the deceased spouse would have reached the age of 70½ or will continue if they had already started, and may be received in two forms: either under the life expectancy rule or the five-year rule. The life expectancy rule results in an amount received monthly which is calculated using a single life expectancy figure for the surviving spouse’s age, which can be found on a life expectancy chart. The five-year rule requires that all funds in the account must be distributed before December 31 of the fifth year following death, and can be withdrawn at any time and in any amount. The five-year method is only applicable if the RMD has not already started, or in the case of an employer-sponsored plan, the option must be available as a plan feature. Neither form of distribution will be subject to the 10% penalty tax.
Spousal Beneficiary Option 2:
The second option available to spousal beneficiaries is to elect to treat the account as his/her own. The spousal beneficiary can do this by rolling over the account into an existing IRA, qualified plan, annuity plan, tax-sheltered annuity plan, or a governmental plan, or by creating a new IRA account. Using this option, contributions can be made to increase the balance of the new account that has been set up, and the RMD will be delayed until the spousal beneficiary reaches the age of 70½. In this case, any withdrawals which are made prior to the age of 59½ will be subject to the 10% penalty tax unless they are rolled into another qualified plan within 60 days (or are made pursuant to one of the exceptions to the 10% excise tax). Under this option, the spousal beneficiary can designate a beneficiary and the RMD made under this option will be calculated based on the joint life expectancies of the spousal beneficiary and his or her beneficiary figure which creates a larger disbursement than with the single life expectancy figure.
The inherited IRA is the only option for non-spousal beneficiaries, and is required for a spousal beneficiary if the retirement account passes through a third party before being distributed to the spouse. With an inherited IRA, only a “Trustee-to-Trustee” transfer (Direct Rollover) may be made from an employer-based plan to an IRA created under the name of the deceased with the designated beneficiary (although President Obama has proposed treating nonspousal inherited retirement accounts the same as spousal inherited retirement accounts for rollover purposes). The inherited IRA assets cannot be mixed with non-inherited assets and contributions may not be made. RMDs must be made using the life expectancy rule or the five-year rule, and are not subject to the 10% penalty tax. The life expectancy rule for an inherited IRA uses the single life expectancy figure based on the age of the beneficiary and must begin the year after the death of the original owner, otherwise, the five-year rule will be required. Qualified plans may permit non-spousal beneficiaries to take lifetime distributions from the plan but many require that the funds be distributed under the five year rule. Qualified plans are required to permit non-spousal beneficiaries to roll over benefits to an inherited IRA.
Option 1: Keep the IRA in deceased spouses’ name
Option 2: Treat the IRA as your own
|Required Minimum Distributions:||Receive Minimum Distribution when decedent would have been 70½ /continue to receive it if RMD already started.||Delay required minimum distributions until surviving spouse reaches 70½.||Distributions must begin one year after death and calculated over the life expectancy of the beneficiary.|
|Five Year Rule||Applicable if spouse dies prior to start of RMD||Applicable if spouse dies prior to start of RMD|
|Withdrawal Penalty:||Can withdraw funds without 10% penalty||Subject to 10% penalty prior to age 59½ unless meet exception||No 10% penalty on distributions, regardless of the age|
|Life Expectancy Rate:||Single Life Expectancy Figure||Joint Life expectancy figure||Single Life Expectancy Figure|
|Allowed Rollovers:||Can only rollover the account into an IRA under the deceased spouses’ name||Can rollover the account into an IRA set up under surviving spouses’ name, or into a pre-existing account under the surviving spouses’ name||Can only make a direct rollover into an IRA created solely for the Inherited IRA|
|Rollover Rule:||60-day Rollover Rule||60-day Rollover Rule||No 60-day Rollover Rule|
|Contributions:||Cannot make contributions / rollovers into account||Can make contributions / rollovers into account||Cannot make contribution / rollovers into account|