Should Your Younger Spouse Roll Over Your IRA After You’re Gone?

Estate Planner Jan-Feb 2001
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If your individual retirement account (IRA) balances are substantial, what’s the best way to plan your estate? Generally, you should name your spouse as the primary IRA beneficiary to provide greater flexibility. After your death, your spouse will have three options. But choosing the best can be complicated, especially if your spouse is younger.

Option 1

Your surviving spouse can keep your IRA in your name and continue to take distributions the same way you took them. Your spouse takes minimum distributions either over his or her life, or over a period not exceeding his or her life expectancy. Even if your spouse is under age 591/2, distributions from the IRS are subject only to income tax, not the 10% penalty for early withdrawals.

This option has great appeal if your spouse is considerably younger than age 591/2 and will most likely withdraw all or substantially all the IRA funds before reaching age 591/2. For example, assume that your estate consists of a house, some small investment accounts and a large IRA and your surviving spouse wants to remain in the house and will need to tap IRA funds to live on. Then income tax deferral will probably not be a concern and this is likely the best option.

Option 2

Your spouse can roll over your IRA into his or her own IRA and name his or her own beneficiaries, such as your children. No matter your spouse’s age at the time, he or she may take distributions over his or her and a beneficiary’s joint life expectancy. The IRA minimum distribution rules require starting distributions by April 1 of the year after he or she turns 701/2. Naming a younger beneficiary allows your spouse to take smaller distributions from the IRA, thus increasing the amount that can continue to grow tax deferred.

A rollover is often the preferred option, but it has one disadvantage if your spouse is younger than age 591/2 when you die: He or she will owe a 10% penalty tax in addition to regular income tax on early withdrawals. (The 10% penalty is not assessed on early withdrawals used for qualified higher education expenses incurred during the same year as the withdrawals.)

Option 3

If your IRA is large enough, the best option may be for your surviving spouse to divide your IRA into separate IRAs maintained under your name. Your spouse then can elect to treat one of the separate accounts as his or her own and roll it over into his or her own IRA, so that it grows tax deferred until he or she reaches age 591/2. Your spouse can take withdrawals from the portion left in your name without incurring the 10% penalty.

For example, Gary, age 52, dies with $1 million in his IRA when his designated beneficiary, his wife, is 40. She rolls $600,000 into a new IRA in her name and designates one child as the beneficiary. Starting when she is age 591/2, she can take distributions from her own account over her and the child’s joint life expectancies. She leaves $400,000 in Gary’s IRA and takes distributions from it — regardless of her age — as needed without incurring a penalty.

Understand the Tax Implications

If your estate consists of a large IRA and your spouse is younger than age 591/2, tax consequences could complicate your and your spouse’s estate plans. Understanding these implications now can help your spouse avoid tax after you’re gone. And for help on how to inform your spouse about your estate plan, please fax back page 6 for a complimentary copy of our Estate MiniPlanner “How To Provide Both Financial Security and Peace of Mind.”