Losing a spouse is one of the most difficult and challenging events a person can face in their lifetime. If you lose your spouse, you’ll no doubt face a number of obstacles in the aftermath, from emotional to legal and even financial. While dealing with retirement accounts and other assets may not be your immediate concern, it’s certainly something you will have to face at some point.
One decision you may have to make is what you should do with your spouse’s traditional IRA. Your spouse likely named you as primary beneficiary, which means you will have access to the funds upon his or her death.
You can certainly cash out the IRA, but that’s not your only option. In fact, that may not even be the best option. Below are four common methods for dealing with a deceased spouse’s traditional IRA. Analyze your needs and goals and determine which option is best for you.
1. Cash it out.
This may be a tempting option, especially if you have a need for cash. However, there is one important consideration to think about before you request a check for the balance.
Distributions from traditional IRAs are fully taxable as income. That means the entire distribution will count as part of your taxable income and you will have to pay income taxes on the full distribution amount.
The distribution could also push you into a higher tax bracket, forcing you to pay higher taxes across the board. You may want to consult with a financial or tax professional before choosing this option.
2. Withdraw it over 5 years.
Another option is to withdraw the funds in equal distributions over a five-year period. This allows you to get the funds relatively quickly, but also spread out the tax obligations over a longer period of time. This may keep you from being pushed into a higher bracket and paying more in taxes. You must elect this option at the time you fill out the beneficiary claim form, and the distributions are managed by the IRA custodian.
3. Keep it as an inherited IRA.
You also have the option of simply keeping your spouse’s IRA and withdrawing from it as needed. The IRA is converted into something called an Inherited IRA. It retains all the same tax treatment and you have control over how the assets are managed. Keep in mind if you are under age 59½, you may face a penalty for making withdrawals.
Technically, the IRA will still be in your spouse’s name with your name attached as beneficiary. That means when your spouse would have turned 70½, you will have to take required minimum distributions, or RMDs, from the IRA. However, they will be based on your life expectancy.
4. Transfer it to your IRA.
Finally, you can always simply do something known as a spousal transfer. You elect to do this at the time you fill out the claim form. The custodian of your spouse’s IRA simply transfers the balance into your IRA. You avoid all penalties and taxes, and you have all your IRA funds in one place.
When you do a spousal transfer, everything becomes based on your age. That means if you are under age 59½, you can’t take a withdrawal without facing a 10-percent early withdrawal penalty. Also, you will have to start RMDs at age 70½, and those distributions will be based on your life expectancy.
Not sure which option is right for you? We know this is a difficult time for you, so we will work with you to make the process as easy and painless as possible. Have a conversation with Hal Hammond in Sarasota about your needs and goals, and determine the route that works best for you.
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