Spousal Rollovers of Retirement Assets Upon Death

Question:        My husband died leaving me as the sole beneficiary of his individual retirement account.  Should I roll over these funds to my own IRA to defer income taxes?

Answer:           The transfer or rollover of a deceased spouse’s Individual Retirement Account (“IRA”) to the surviving spouse’s IRA is the customary action taken by the spouse who is the beneficiary of his or her deceased spouse’s account.  A spousal rollover is not optimal, however, in all cases.

A surviving spouse who is the beneficiary of his or her deceased spouse’s IRA can transfer the funds in the decedent’s IRA to the spouse’s IRA.  While your question addresses IRAs, the same rollover opportunity exists with respect to profit sharing, 401(k) and most other types of qualified retirement plan assets held by a decedent. The funds rolled over become part of the spouse’s IRA and are subject to the statutory minimum distribution requirements when the spouse reaches age 72.  For a spouse who has not attained age 72, no withdrawals will be required until the spouse attains this age, thereby permitting the funds to continue to accumulate on a tax-deferred basis. Only a surviving spouse is permitted to roll over the IRA assets of a decedent; any non-spouse beneficiary of a decedent’s IRA must treat the decedent’s IRA as an inherited IRA and withdraw funds on a periodic basic generally over a time period of no more than ten years.

The situation is somewhat different for a younger surviving spouse.  Penalties are imposed on IRA owners who withdraw funds from their IRAs prior to attaining to 59 ½, subject to certain exceptions set forth in the Internal Revenue Code. One exception is distributions made reason of a decedent’s death. However, a surviving spouse who has not attained age 59 ½ and rolls over the deceased spouse’s IRA funds to the spouse’s IRA and then withdraws funds from the spouse’s IRA prior to attaining age 59 ½ could be subject to a ten 10% penalty tax on the funds withdrawn prior to this age. 

From a planning perspective, if the surviving spouse is younger than age 59 ½ and does not need nor anticipate needing access to the deceased spouse’s IRA, the spouse should proceed with the conventional rollover of funds to the spouse’s IRA.  But a surviving spouse who is younger than age 59 ½ who may need access to the deceased spouse’s IRA would be better served by not consummating a rollover.  Rather, the surviving spouse should leave the funds in the deceased spouse’s IRA where the spouse can withdraw funds and avoid the 10% penalty tax even though the spouse has not yet attained age 59 ½.  Because the funds remain in the decedent’s IRA, the funds withdrawn by the spouse will qualify for the death exception to the penalty tax.

One drawback of not consummating a rollover is that assets of the deceased spouse’s IRA are subject to minimum distribution requirements which apply to inherited IRAs.  This consequence may be of little concern to the surviving spouse who needs money as the IRA funds would need to be withdrawn in any case.  However, once the surviving spouse attains age 59 ½, the spouse can rollover the remaining funds in the decedent’s IRA to the spouse’s IRA and defer the required minimum distributions until the spouse reaches age 72.  Also noteworthy is that the funds held in an inherited IRA are subject to the claims of the surviving spouse’s creditors while funds rolled over to the surviving spouse’s IRA are afforded certain creditor protection.

A rollover is clearly the most common form of dealing with decedents’ retirement assets.  Spouses who have not reached age 59 ½, however, should be careful before consummating the conventional rollover as they may inadvertently incur tax consequences they did not anticipate.

The Tax Corner addresses various tax, estate, asset protection and other business matters. Should you have any questions regarding the subject matter or if you have questions you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfbbg.com.

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