Understanding an IRA Inherited From Your Spouse

Bridget F. Wall is an advanced planning attorney at Northwestern Mutual.

Losing a spouse is a profoundly difficult experience, and it's common to feel overwhelmed by the decisions that need to be made during such a time of grief. Alongside the emotional challenges, you may find yourself inheriting financial assets like an individual retirement account (IRA).

Below, you’ll get a closer look at what an inherited IRA is, how it works and what happens when you inherit an IRA from a spouse. And you’ll see the options for handling the assets in the account.

What is a spousal inherited IRA?

Before we get into all the details, it’s important to understand that inheriting an IRA from your spouse who passes away is different from a spousal IRA. A spousal IRA is a type of retirement account that allows a working spouse to make retirement contributions for a nonworking spouse.

Inheriting an IRA from your spouse means that the IRA becomes your property after the spouse who originally owned it dies. It might be called a spousal rollover IRA or simply an inherited IRA.

What happens when you inherit an IRA from your spouse?

As a spouse, you don’t always automatically inherit an IRA. And how the transfer, or distribution, works depends on whether you were listed as the sole account beneficiary or will share the inheritance with others.

• If you were listed as the sole beneficiary on your spouse’s IRA, you’ll usually get control of the account relatively quickly following their death. This often happens within a few days or weeks of providing a death certificate to the IRA’s custodian.
• If no beneficiary was listed, default beneficiary provisions may kick in. And if there are no default provisions or if the named beneficiary died before your spouse, the IRA may become part of your spouse's estate. The assets would then be distributed according to the terms of the will or, if there is no will, according to state laws.

Once you know the IRA is coming your way, there’s a good reason to pay attention to the calendar. If your spouse was required to take a payout called a required minimum distribution (RMD) in the year they died but did not yet take it, you’ll need to do so. If December 31 passes without the RMD, you could be penalized by 10 to 25 percent of the amount you were supposed to withdraw.

What can you do when you inherit an IRA from your spouse?

Most nonspousal beneficiaries who inherit an IRA are required to take all the money out (or "fully distribute the IRA") within 10 years after the original owner's death. But the rules are different for spouses, and it can be a good time to get advice from your financial advisor. The best course of action often depends on specific legal, financial and personal circumstances. You’ll generally have four options.

Spousal rollover IRA

If you are the sole beneficiary of your spouse’s IRA, the IRA can be retitled to your name or rolled into your own IRA. You can make a spousal rollover election for all or just part of the IRA. The IRA will then be yours for all purposes.

For example, it will be subject to the same rules that normally apply to IRA withdrawals. So, a withdrawal while you are under 59½ years old will mean a 10 percent early withdrawal penalty—on top of regular income taxes—unless you qualify for an exception.

This option might make sense if you are still working and don’t need access to the money to make ends meet because the assets might continue growing. (The assets will rise and fall according to the market.) This option can also make sense if you inherited a traditional IRA account and want to pursue a Roth conversion, which would allow you to pay income taxes upfront for tax-free withdrawals in retirement.

Open an inherited IRA

Another option is to transfer the assets to an inherited IRA. If so, you'll be required to take RMDs by the end of the year following your spouse's death, or you can delay beginning RMDs until your spouse would have turned age 73. Note that there are nuances around titling the account properly, so make sure to work with the IRA custodian on registering the account properly.

While distributions and withdrawals will be taxed at your regular rate, they won’t be subject to the 10 percent early withdrawal fee—even if you have not reached retirement age. Withdrawals from an inherited Roth IRA will be tax-free in most cases.

This can be a good option if you think you might need access to your spouse’s savings before you reach retirement age but do not want to liquidate your account. It can allow the assets to continue growing tax-deferred. Of course, the assets might also decrease in value if the market takes a downturn.

Take a lump-sum distribution

You could decide to take all of the IRA’s assets at once via a lump-sum distribution. It’s essentially a payout from the IRA, and you’d get all of the money in the account to use as you please. While the distribution wouldn’t be subject to the 10 percent early withdrawal penalty, you’d need to pay income taxes. The tax rate would simply be your income tax rate.

This option can make sense if you have an immediate need for the money—for example, if you need to make critical home repairs, have medical bills, or want to pay down "bad debt” like a credit card balance. But you’ll forfeit the tax benefits that you’d receive by keeping the money in an IRA.

Disclaim the IRA

If you don’t need or want the money, you could choose to “disclaim” the IRA. If so, you won’t have any control over the account. The IRA will go to the remaining primary beneficiaries or the contingent beneficiaries named by your spouse. They should fully distribute the account in 10 years or face potential penalties of 10 to 25 percent.

This option can make sense if you don’t need the money and believe that it would be put to better use by your child, grandchild or someone else close to you. Or you might believe this option would better fulfill your deceased spouse’s wishes. It can also make sense if you already have significant assets and currently exceed (or are approaching) the estate tax exemption.

Disclaimed assets, including IRAs, don’t become a part of your estate and will not be subject to estate taxes upon your death. If you’re about to inherit a spousal IRA during a down market, you might decide to decline it so that a younger generation can benefit from a longer investment horizon. This could allow the funds to compound over a longer period (or they might further decline).

If you might disclaim the IRA, a financial advisor can take a look at the health of your finances. Together you can decide whether or not that would be a wise decision.

Planning for the years ahead

As you plan for the years ahead, your Northwestern Mutual financial advisor can provide clarity during a challenging time. These rules are complicated, and your advisor can help you understand all of your options. Together, you can keep working toward goals you and your spouse established. Your advisor might even point out opportunities or blind spots that would otherwise be overlooked, such as leaving a donation to charity.