Beneficiary Planning for Retirement Accounts, Part I – Leaving it to your Spouse

Completing and periodically reviewing beneficiary paperwork is the one of the most important administrative tasks a retirement plan participant can take. Overlooking this seemingly easy step can lead to the wrong individual(s) inheriting your retirement nest egg; there have been too many unfortunate stories regarding non-updated beneficiary designations to leave this unattended. Hence why, like all estate planning documents, periodic check-ups should be implemented so that any necessary changes are made in a timely manner.

Equally important is being familiar with the complex maze of government rules that apply when an account is inherited. For example, different sets of rules apply depending on who inherits an account, be it an individual other than a spouse, a trust, or a charity. We will cover these rules over the next few blog posts, but first we will tackle the most common inheritance circumstance: leaving your accounts to your spouse.

In a majority of situations, IRA owners who are married name their surviving spouse as their designated beneficiary. By far the least complex when it comes to the rules, a spouse inheriting an IRA or other types of qualified retirement plans is pretty straightforward. When a spouse is the "sole spouse beneficiary" there are three options available to him/her that are not available to non-spouse beneficiaries:

  1. Choose a Spousal Rollover. Here a surviving spouse can roll over the deceased’s IRA into his or her own. The rollover can be accomplished directly or via a 60-day rollover. Upon completing the rollover, the assets (now in the surviving spouse’s IRA) are treated as if they were always there. The surviving spouse no longer is treated as a beneficiary. Instead he/she is now the account owner, and all distribution rules governing their IRA apply. A spousal rollover is irrevocable,
  2. Elect to Treat IRA as Your Own. Similar to option 1, but no rollover required. As with the spousal rollover, this option, once taken, is irrevocable.
  3. Remain a Beneficiary. The last option generally is preferred when the surviving spouse is younger than 59½ at the time they inherit the account. This allows the surviving spouse to take distributions from the inherited account at any time and for any reason without incurring the 10% early-distribution penalty that otherwise would apply to someone younger than 59½. They will, however, in most cases be subject to ordinary income tax on this distribution* and have to take an annual Required Minimum Distribution.

*Different tax rules apply to inheritors of Roth accounts: Distributions may be taken without being taxed (provided that the five-year holding period has been met), otherwise only earnings are taxable.