What You Can Do With an Inherited IRA From Your Spouse

Losing a spouse is a devastating event and adjusting to an altered life while dealing with all the financial decisions can be overwhelming. One of the financial decisions you'll have to make is deciding how you want to treat it when you inherit it if your spouse had an individual retirement account (IRA).

A different set of rules would apply if you inherit an IRA from someone other than a spouse.

If You Inherit a Traditional IRA From Your Spouse

There are two primary types of IRAs you can inherit: a traditional IRA or a Roth IRA. You have three choices if you inherit a traditional IRA from your spouse:

1. Cash the account in
2. Transfer it to your account
3. Be a beneficiary

The Internal Revenue Service (IRS) has specific rules for each situation.

You Can Cash It In 

You'll pay income taxes on the amount withdrawn if you cash in the IRA, but no penalty taxes will apply regardless of your age. This option is a good thing because IRA distributions before age 59½ are normally subject to a 10% early IRA withdrawal penalty tax.

But cashing in the IRA might not be your best choice, even taking the penalty tax off the table. You have to consider your tax bracket. Cashing in a large IRA could mean that anywhere from 24% to 37% of it goes straight to federal taxes. State income taxes may apply, too. You might be better off withdrawing the money as you need it instead of cashing in the entire inherited IRA all at once. 

You Can Treat the IRA As Your Own 

You can treat the IRA as your own by naming yourself as the account owner or by rolling the inherited IRA into your own IRA account. This method can often be your best choice if you're over age 59½ or if your spouse was older than you.

Rolling the funds allows you to delay taking required minimum distributions (RMDs) as long as possible. Your future RMDs will be determined based on your age if you choose to treat the IRA as yours, beginning with the year you become the owner.

Here's an example: Let's say that your spouse was 74. You're 67. Your spouse started taking their RMDs at age 72. You elect to treat the inherited IRA as your own. You don't have to take annual RMDs until you reach age 72. even though your spouse was already doing so. The clock effectively resets.

The advantage here is continued tax deferral. You can still take withdrawals if you need the money and no penalty tax will apply if you're over age 59½, but you're not required to do so until you reach age 72.

But here's a word of warning: If you're not yet 59½ and you choose to treat the IRA as your own, your distributions will be subject to a 10% penalty tax.

You Can Name Yourself As the Beneficiary 

This option can be your best choice if you're under age 59½ or you're older than your spouse. When you set up the account so that you're considered to be the beneficiary of the inherited IRA, your required minimum distributions are determined by your spouse's age at the time of their death. This dating can present two possibilities.

If your spouse died after their RMDs began because they were over age 72, you must take distributions based on the longer of:

• Your deceased spouse’s life expectancy based on their previous RMD schedule 
• Your own single life expectancy

If your spouse died before their RMDs began, you can defer distributions until their RMDs would have started and take distributions then over your single life expectancy.

The advantage of this choice is that you can take withdrawals if necessary and no penalty tax will apply if you're not yet 59½. And if you're older than your spouse, you can defer the RMDs until your spouse would have been required to take them, which will be a later date than your own age 72.

Frequently Asked Questions (FAQs)