3713.04 / What should surviving spouses who inherit IRAs know when deciding how to treat the inherited account?

The original SECURE Act sharply limited the distribution options for most IRA beneficiaries who inherit accounts in 2020 or thereafter. Surviving spouses are one of the few enumerated groups of individuals who continue to be eligible for taking inherited IRA distributions over their life expectancy post SECURE Act. However, as before the SECURE Act, surviving spouse beneficiaries have multiple options when it comes to determining how to treat an IRA that was inherited from a spouse. The choice the surviving spouse makes will impact the rate of distributions that must be taken from the inherited IRA—which, of course, can have a substantial impact on the survivor’s tax liability over the years. Because surviving spouses have a limited amount of time to make their election, it’s important to ensure that clients understand their choices—and the consequences of those choices.

Surviving spouses can, of course, continue to treat the IRA as a beneficiary (inherited) IRA like any other designated beneficiary. They also have the option of rolling the inherited account balance into their own IRA or an employer-sponsored retirement account. As a third option, surviving spouses can elect to treat the inherited IRA as their own.

Under proposed regulations related to the SECURE Act, however, the IRS has clarified that the surviving spouse has only a limited amount of time to elect to treat the IRA as their own.

Under those proposed regulations, the surviving spouse must make the election before the later of (1) the end of the year in which the surviving spouse reaches their required beginning date or (2) the end of the year following the year of the original account owner’s death.

The spouse beneficiary’s RMD obligations will depend on how they elect to treat the account. If the spouse treats the inherited IRA as an inherited IRA, the account will be registered in both the name of the deceased spouse and the surviving spouse (surviving spouse as beneficiary of deceased spouse). As an “eligible designated beneficiary,” the spouse beneficiary can take RMDs using their own life expectancy or the ten-year rule. The ten-year rule may be required under the terms of the IRA agreement or if the spouse beneficiary makes the election.

Under the beneficiary IRA option, RMDs must begin by the later of (1) December 31 of the year after the year the original owner died or (2) the year in which the original owner would have been required to start taking RMDs.

If the spouse beneficiary treats the inherited IRA as their own, they simply redesignate the account in their own name. RMDs are calculated based on the individual’s own life expectancy using the Uniform Lifetime Table.

While the spouse beneficiary can roll over amounts to their own IRA, they cannot roll over RMDs. That means they could be subject to a pre-rollover RMD requirement if some time has passed since the original account owner’s death.

Before rolling over the account balance, the spouse beneficiary must take a distribution if both of the following are true: (1) the rollover is occurring before the end of the ten-year period that applies to inherited IRAs and (2) the rollover is occurring after the spouse beneficiary reaches their required beginning date.

The RMD amount is the RMD that would have been required for the years prior to the year of rollover had the spouse used the life expectancy distribution method instead of the ten-year rule (reduced by any distributions that the spouse beneficiary actually took during those years). Once the rollover is complete, further RMDs are calculated using the Uniform Lifetime Table.

Although time is limited for a surviving spouse to elect to treat the IRA as their own, surviving spouses may continue to initially treat the IRA as a beneficiary IRA and later elect to roll the account funds into their own IRA. However, the surviving spouse may be subject to the RMD requirement discussed above because the survivor is not entitled to roll over RMDs into their own account.

For spouse beneficiaries who are under age 59 ½, however, leaving the funds in a “beneficiary IRA” has an added benefit. Distributions will be exempt from the 10 percent early distribution penalty that would apply if the surviving spouse took a distribution from an IRA treated as their own. IRA custodians must elect “Code 4” in Box 7 of the taxpayer’s Form 1099-R.

Spouse beneficiaries who elect to treat the account as their own have the ability to make contributions, convert funds to a Roth account or roll funds over under the traditional IRA rules.

Once a taxpayer makes the decision to roll the inherited IRA into their own account or treat the inherited IRA as their own, they cannot later revoke those decisions. Beneficiaries who are uncertain may wish to initially register the inherited IRA as a beneficiary IRA and roll the funds over into their own account if the move is preferential from a tax standpoint.