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The Spouse as IRA Beneficiary: Financial Considerations & Investment Options

written by: ciel s cantoria•edited by: Ronda Bowen•updated: 5/23/2011

This article gives particular attention to the spouse as IRA beneficiary, whose financial considerations & investment options are more extensive than that of a non-spousal beneficiary. However, due to lack of familiarity & economic need, most spouses tend to forgo the benefits of their privileges.

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    Knowing the Privileges of a Spouse as IRA Beneficiary Over a Non-Spousal Beneficiary

    800px-Forlorn Widow's Walk 

    Traditionally, an IRA owner names his or her spouse as IRA beneficiary. Financial considerations and options vary as to how an IRA inheritance is treated, in the event that a spouse passes away. The surviving spouse has special rights and special contribution privileges that allow him or her to skip any estate proceedings regarding the inherited IRA assets.

    This stands opposed to the circumstances surrounding a non-spousal beneficiary of an IRA inheritance. In such cases, the only right of a non-spousal beneficiary is to move into the inheritance as a beneficiary of an IRA trust account naming him or her as the recipient. Under this condition, he or she will be required to withdraw the inheritance within a specific period, while the IRA account shall remain in the name of its deceased owner.

    We can simply surmise that the federal government greatly favors the spouse as IRA beneficiary. Financial considerations and privileges extended to spousal IRAs are numerous and allow more flexibility; the extent of which could even benefit the deceased IRA owner’s children and grandchildren.

    The spouse, as IRA beneficiary, should consider the other options available to him or her, beyond the financial considerations that will be received as inheritance.

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    The Financial Considerations & Investment Options of a Spousal IRA Beneficiary

    Under a general tax rule, within nine months from the date of the IRA owner’s death, a spousal IRA beneficiary should make a decision on how he or she wants the IRA inheritance to be treated. In which case, the surviving spouse will choose from any of the following options:

    1. Move into the Inheritance as a Beneficiary-

    A spouse may opt to assume the role of the beneficiary to an IRA inheritance simply because she needs money to meet the family’s present needs. As such, she can withdraw or take minimum distributions from the account sans the 10% withholding tax and should do so within a year from the date of inheritance. The entire balance of the IRA asset should be taken out of the account within five years. All withdrawals during the said time limit will still be free of the 10% withholding tax.

    One of the important facts that a surviving spouse should know is that the tax free connotation of the distribution received as inheritance is the 10% withholding tax for early deductions. Federal tax rules provide that they should still be reported as part of the inheritor-taxpayer’s gross income.

    Nonetheless, the advantage of being a spousal IRA beneficiary is having the privilege to rollover part of the inheritance into becoming one’s own IRA investment account. That way, part of the distribution can be retained as an income earning investment under the rules and provisions of the IRA plan. A provision to take note of is the condition that the new IRA should be of the same type as that of the inheritance, e.g. traditional to traditional.

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    The Financial Considerations & Investment Options of a Spousal IRA Beneficiary (continued)

    2. Move into the IRA account by designating one’s self as the new owner of the inherited asset.

    A person who inherits a spouse’s IRA as a sole beneficiary has the privilege to assume ownership of the entire inheritance and become the new owner. Under this circumstance:

    • The privilege afforded to a beneficiary is forfeited, which means any amount taken out as early distribution before the age of 59 ½ will be subject to the 10% withholding tax.
    • As the new owner of the IRA account, contributions can be made through April 1 of the year after the said inheritor turns 70 ½ years of age.
    • Treatment of the inherited account will now be based on the surviving spouse’s life expectancy---to which the required minimum distribution shall take effect as basis on April 1 of the year after he or she turned 70 ½ years of age. Nonetheless, the surviving spouse, can opt to take the minimum required distribution based on the deceased owner’s life expectancy, if he or she so prefers.

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    3. Roll the inherited IRA into one's existing IRA account.

    By this, it means that the surviving spouse receives the inheritance as a tax-free distribution but contributes the same to his or her existing IRA plan.

    As a general rule, the inheritance must be treated as a rollover contribution of one’s existing IRA account, within sixty days after receiving the amount as an IRA distribution. Otherwise, distributions reinvested after the 60-day time limit no longer qualify as a tax-free rollover treatment.

    Accordingly, a spousal IRA inheritance that is rolled-over, presents the best option as far as stretching the life expectancy is concerned. The surviving spouse can name a new and younger beneficiary and their joint life expectancy would stretch the distribution period of the required minimum distribution.

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    Summary:

    The federal government greatly favors the spouse as IRA beneficiary. Financial considerations, however, should be placed under the advisement of a tax professional, in order to fully comprehend the tax implications of a substantial windfall. This is in view of the fact that many opt to receive the inheritance in full as a beneficiary, which could be due to the present economic conditions. However, the tax deferral and long-term benefits afforded by IRA plans are often overlooked.

    In fact, some spouses or even non-spousal beneficiaries who are not too familiar with the mechanics of IRA's benefits are of the misconception that an IRA inheritance is tax free. They require a greater understanding that an IRA distribution doled out as inheritance is exempt only from the 10% withholding tax required for early distribution. As a result, spousal IRA beneficiaries, realize too late that they could have maximized the inheritance had they considered the other options.

    In knowing the privileges of a spouse as IRA beneficiary, financial considerations can be carefully planned and programmed according to the distribution rules. That way, the elements and benefits of tax deference would be optimized.

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    Reference Materials and Image Credit Section:

    References:

    • Traditional IRAs IRS Publication 590---http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230568

    Image Credit:

    • Forlorn Widow's Walk at Wikimedia Commons -- http://commons.wikimedia.org/wiki/File:Forlorn_Widow%27s_Walk.png

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