Roll Over the Remaining Interest of an Inherited IRA or Retirement Plan
What is it?
If your spouse dies and you are a primary beneficiary of their traditional IRA or retirement plan account, you may be able to roll over the inherited funds to your own traditional IRA or plan account. This is generally true even if your deceased spouse had begun taking required minimum distributions (RMDs) from the account, and even if you have begun taking RMDs from your own IRA or plan. This option is available only to surviving spouse beneficiaries. If you are a child of the deceased or any other type of beneficiary, you cannot do a rollover.
While nonspouse beneficiaries cannot roll over inherited funds to their own IRA or retirement plan account, the Pension Protection Act of 2006 does allow nonspouse beneficiaries to make a tax-free direct rollover of death benefits from an employer retirement plan to an inherited IRA in some cases.
The rollover option allows the inherited funds to continue to grow tax deferred in the new IRA or plan, and provides other advantages as well (as discussed below). If you exercise this option, you generally have the choice of doing either a direct rollover or an indirect rollover. A direct rollover is a transfer of funds from one IRA or plan trustee to another trustee at your request. An indirect rollover involves an extra step. You receive the IRA or plan funds in the form of a check made out directly to you, and you then transfer those funds to the receiving trustee yourself.
If you are a surviving spouse beneficiary of an IRA or plan account, it will very often be to your advantage to roll over the inherited funds to your own traditional IRA or plan. However, be aware that this is not the only option available to you as a surviving spouse beneficiary. Other options exist for taking post-death distributions and, in some cases, one of these other options may be preferable.
This discussion does not apply to Roth IRAs. Although you can roll over an inherited Roth IRA, the fact that qualifying distributions are income tax-free changes some of the considerations discussed here.
The surviving spouse of a deceased participant in a 401(k) or other qualified retirement plan is able to make a tax-free rollover to another qualified plan, a 403(b) plan, or a Section 457 plan, in addition to doing a rollover to an IRA.
Are there any restrictions on the spousal rollover option?
If a traditional IRA owner or retirement plan participant dies, and you are the surviving spouse beneficiary, you may be able to roll over the inherited funds to your own traditional IRA or plan. However, note the following restrictions:
- You cannot roll over RMD amounts (i.e., distributions that are required to be taken for the year of the IRA owner's or plan participant's death).
- In the case of post-death distributions from a retirement plan account, the plan may specify the distribution options available. Those options may or may not be identical to the allowable options set forth in the IRS distribution rules. You should consult the administrator of the retirement plan for details regarding options available to you as a surviving spouse beneficiary.
Advantages of the spousal rollover option
A rollover is not a taxable distribution
In general, distributions from inherited traditional IRAs and retirement plans are included in the beneficiary's taxable income for federal (and possibly state) income tax purposes. (If the IRA or plan contains any nondeductible or after-tax contributions, distributions may not be fully taxable.) However, if you are a surviving spouse beneficiary, a rollover of the inherited funds to your own IRA or plan is generally treated as a tax-free transfer of assets. Assuming that the rollover is done properly and in a timely manner, you will not be considered to have taken a taxable distribution from the inherited IRA or plan. This is generally true whether you do a direct rollover or an indirect rollover. However, once the rollover to your own IRA or plan is complete, distributions that you take from that account will be fully or partially taxable. See below for information on when distributions from your own IRA or plan must begin.
You generally must complete an indirect rollover within 60 days, or you will be assessed taxes and/or a penalty on the distribution. However, there are several ways to seek waiver of the 60-day deadline, including an automatic waiver in some cases, self-certification if you missed the deadline due to one of eleven specified reasons, or by requesting a private letter ruling from the IRS.
You may be able to defer taking distributions
If you are the surviving spouse beneficiary of an IRA or retirement plan and elect the spousal rollover option, the inherited funds will be moved to your own IRA or plan account. This is significant because as the owner of the new account, you do not have to begin taking distributions of the inherited funds until your own required beginning date (the date by which an IRA owner or plan participant must begin taking annual RMDs from the account). In most cases, this date is April 1 of the year following the year in which you reach age 73 (75 if you reach age 73 after 2032). Depending on your age at the time of your spouse's death, you may have to start distributing the funds immediately or soon after you complete the rollover. However, if you are under age 73 (75 if you reach age 73 after 2032), you can generally wait to begin taking distributions. This would allow you to defer income tax liability on the funds, and to maximize the funds' tax-deferred growth potential.
Henrietta (age 64) is the designated beneficiary of her late husband Ed's traditional IRA (Ed was 74 at the time of his death). Henrietta is not in immediate need of such a large sum of money, and wants to keep her income tax liability to a minimum. She can take advantage of the spousal rollover option, even though Ed had already begun taking distributions before he died. A final required distribution must be made for the year of Ed's death (and if he hasn't received it by the time he dies, Henrietta must take it). After Henrietta rolls over the remaining balance of the inherited funds to her own IRA or plan, distributions are not required to begin again until her own required beginning date.
The funds continue to grow tax deferred in the new IRA or plan
A rollover is a transfer of assets from one tax-deferred retirement savings vehicle to another. Just as the funds benefitted from tax-deferred growth in your late spouse's IRA or plan account, so they will continue once deposited in your own IRA or plan account. If you are under age 73 (75 if you reach age 73 after 2023), the full amount of the inherited funds will be able to grow tax deferred until you begin taking distributions from your own IRA or plan account. Even if you must begin taking distributions immediately [either because you are already age 73 (75 if you reach age 73 after 2032) or older, or because you need the money], those distributions can generally be spread over a period of years, allowing the balance of the funds to grow tax deferred until distributed. The longer the payout period, the greater the tax-deferred growth opportunities.
You can choose beneficiaries for your own IRA or plan account
If you are a surviving spouse beneficiary and choose to roll over inherited IRA or retirement plan funds, those funds are transferred to your own IRA or plan account. This is important because as an IRA or plan account owner, you have certain rights, including the right to name one or more beneficiaries of your choice. Your options when choosing IRA or plan beneficiaries generally include your children, your grandchildren, other relatives or friends, a trust for the benefit of your loved ones, a charity, or your estate. These are the individuals or entities that will receive the IRA or plan funds after your death. The ability to choose your own beneficiaries can be a significant advantage in terms of your estate planning.
Even if you do not choose to roll over the inherited IRA or retirement plan funds, check with the IRA trustee/custodian or plan administrator — some plans now allow you, as beneficiary, to name your own beneficiaries to receive any funds remaining in the account after your death.
Disadvantages of the spousal rollover option
If you are a surviving spouse beneficiary, the ability to roll over inherited IRA or plan funds to your own IRA or plan can be a powerful planning option. That is why many surviving spouse beneficiaries choose to exercise this option. One potential drawback of the rollover option is that distributions from your own IRA or plan account may be subject to the 10% early withdrawal penalty if you are under age 59½. By contrast, distributions of the inherited funds from your late spouse's IRA or plan account to you as beneficiary of that account would not be subject to this penalty, regardless of your age (or your spouse's age when he or she died). In addition, there may be rare cases in which taking post-death distributions under another method can provide greater income tax deferral than the rollover option. Consult a tax advisor for more information.
How to do a rollover
Choose between a direct and an indirect rollover
As discussed above, there are two types of rollovers: direct and indirect. If you want to exercise the spousal rollover option, your first step is to decide on the type of rollover. A direct rollover generally makes more sense because it is more streamlined and less risky. An indirect rollover involves an extra step, and in the case of an inherited retirement plan account, the distributed funds will be subject to a 20% mandatory withholding for federal income tax.
Choose the rollover account
If you have more than one retirement account, you must choose the account that you would like to receive the rolled over funds. For example, if you have inherited your late spouse's retirement plan account, you may be able to roll over those funds to either your own plan account or your own traditional IRA. If you do not currently have your own retirement account to receive the inherited funds, you can generally establish a traditional IRA for this purpose. Traditional IRAs can be established with banks, mutual fund companies, and other financial institutions.
Submit the necessary form to the IRA custodian or plan administrator
As a surviving spouse beneficiary, you will need to contact the IRA custodian or plan administrator to request the necessary form for a rollover, whether direct or indirect. Return the form with any necessary documentation (such as identification and a death certificate), indicating that you want to roll over the inherited funds to your own IRA or plan account.
Make sure the new trustee receives the funds within 60 days
If you fail to complete an indirect rollover within 60 days of the date on the check, you may have effectively changed your rollover into a lump-sum distribution. This would cause all or a portion of the funds to be included in your taxable income for federal (and possibly state) income tax purposes. However, there are several ways to seek waiver of the 60-day deadline, including an automatic waiver in some cases, self-certification if you missed the deadline due to one of eleven specified reasons, or by requesting a private letter ruling from the IRS.
The IRA or plan trustee will send you IRS Form 1099-R (Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) when you do an indirect rollover, because you are receiving a distribution in this case. (This form may also be sent to you when you do a direct rollover.) However, you will not actually be subject to income tax on the funds unless you fail to complete the rollover in a timely fashion (though a mandatory withholding requirement will apply in the case of an indirect rollover from a retirement plan account).
