IRAs now represent the largest share of retirement assets in the United States, outpacing both Defined Contribution (DC) and private Defined Benefit (DB) plans. Now reaching nearly $5 trillion in total assets according to the Investment Company Institute (ICI), roughly 25% of total IRA assets are owned by individuals age 65 and older.* As more baby boomers retire and the nation’s overall population continues to age, more IRA assets will be owned by older individuals. It will be increasingly important for advisors to assist clients in managing the distribution of these assets not only for their own benefit but also to provide lasting retirement income for clients’ surviving spouses as well. Spouses who are beneficiaries of IRA plans benefit from unique planning advantages if those accounts are established and managed properly. The key advantage or differentiator is that spousal beneficiaries, unlike beneficiaries who are non-spouses, may elect to treat an inherited IRA as their own upon the death of the IRA owner. In essence, ownership of the IRA is transferred from the deceased account owner to the surviving spouse. In some cases, the surviving spouse may be better off remaining a beneficiary of the inherited IRA versus becoming an owner of the IRA. We will explore different circumstances to highlight why one approach may make more sense than the other.
PLANNING WHILE THE IRA OWNER IS STILL LIVING
The starting point is making sure clients list and continually update beneficiary designations on their IRAs and other retirement accounts. Failure to list beneficiaries or listing the incorrect beneficiaries can be a costly problem that is easily avoided through periodic beneficiary “check-ups”.
In the case of spouses, only spouses who are sole, primary beneficiaries can take advantage of the option to take ownership of the IRA upon death. For this reason, an IRA owner who wants to leave assets to both a spouse and children may want to consider establishing separate IRAs — each with its own beneficiary designation. This will maintain all of the spousal beneficiary’s options while ensuring that assets are distributed per the IRA owner’s wishes.
Assuming that proper beneficiary planning has been established, what are the key factors for surviving spouses to consider when they inherit an IRA? Specifically, when does it make sense to take ownership of the IRA (commonly referred to as a “spousal rollover”) vs. maintaining the account in the ownership of the deceased owner’s name and remaining a beneficiary?
WHEN A SPOUSAL ROLLOVER MAY MAKE SENSE
| 1. The deceased spouse is older than the beneficiary spouse | In this case, the surviving spouse may be able to delay RMDs, suspend RMDs, or reduce RMDs based on their lower age factor. For example, let’s suppose the IRA owner dies at age 73 after RMDs have started. If the surviving spouse is age 65 for example, once the RMD for the year of death is taken, he/she could roll the rest of the IRA into his/her own IRA and avoid RMDs until reaching age 70½. |
| 2. To allow contingent beneficiaries like children to stretch IRA distributions | If the surviving spouse rolls the IRA balance into his/her own IRA, subsequent beneficiaries may be listed on the account upon the death of the surviving spouse. These subsequent beneficiaries will have the option of taking (smaller) RMDs based on their remaining life expectancy. |
| 3. Ability to use the uniform lifetime table in calculating RMDs. | Spouses who elect to make the IRA their own can base RMDs on the uniform lifetime table vs. the single lifetime table, which will result in a lower RMD (these tables can be accessed at http://www.irs.gov/publications/p590/index.html.) |
| 4. Simplicity of paperwork and recordkeeping | Surviving spouses who have their own IRAs may find it easier to roll over the IRA of their deceased spouse into their existing IRA for account consolidation – one statement, easier to keep track of asset allocation, RMDs, and manage withdrawals. |
WHEN LEAVING THE IRA IN THE NAME OF THE DECEASED (commonly referred to as a “beneficiary IRA”) MAY MAKE SENSE
| 1. The surviving spouse is younger than age 59½ and needs access to IRA funds. | By leaving the IRA in the name of the deceased, any withdrawals would not be subject to the IRS early 10% withdrawal penalty because of the death exception. However, the distribution would generally be considered taxable income. Once the surviving spouse reaches the age of 59½ where the 10% penalty would no longer apply, he/she could then request a spousal rollover to take advantage of the other benefits outlined above. |
| 2. The surviving spouse is older than the deceased spouse. | Maintaining the IRA in the name of the deceased IRA owner may result in lower RMDs since the IRS “life expectancy” of the older, surviving spouse will be smaller. Remember, the smaller the life expectancy factor, the greater the RMD. In addition, if the deceased spouse was younger than 70½ (age 65 for example) and the surviving spouse is older than 70½, RMDs could be deferred until the deceased owner would have reached the age of 70½. Note that non-spouse beneficiaries cannot take advantage of this option. |
*Source: EBRI, May 2010.
Chris Hennessey is the Faculty Director of the Babson College School of Executive Education and member of the Putnam Investments Business Advisory Group. His opinions do not necessarily reflect those of Putnam Investments.
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