Options for a Spouse as Beneficiary of a Retirement Account

Tax News You Can Use | For Professional Advisors

December 2, 2024

The Tax Code creates a wide range of incentives for taxpayers to provide for a surviving spouse after death. Whether this is to help a destitute widow avoid the need for public support or to align the treatment of those in common law marital property states with those in community property states, the result is the same. In the retirement benefits arena, a spousal beneficiary has a wider array of options than any other beneficiary with respect to the rules that govern the length of deferral and distribution patterns from IRAs.

In general, the identity of the person or entity named by the account owner (with some adjustments permitted prior to September 30 of the year following the year of death) determines the tax treatment of an IRA or qualified plan account (Retirement Account), and the required minimum distributions (RMDs) for that Retirement Account. Most Retirement Account beneficiaries who are not surviving spouses have ten, or even fewer, years over which to withdraw the assets to avoid penalties. The Tax Code permits certain categories of eligible designated beneficiaries (EDBs) to withdraw assets over the EDB's life expectancy, which is determined under the single life table and based on the EDB's age on the account owner's date of death.

Surviving spouses have four options for Retirement Accounts. For this purpose, Retirement Accounts does not include Roth accounts.¹

• An Inherited IRA. A spouse is an EDB under the Code and, like any other beneficiary, can establish an inherited IRA. The spouse must start RMDs the year following the decedent's death, and calculate RMD's using the single life table. There are no early withdrawal penalties even if either or both of the decedent and the surviving spouse are under age 59 ½.
• A Spousal Rollover. A surviving spouse may elect to roll the assets from the Retirement Account over into an existing or newly created IRA of their own. Once the assets are in the spouse's IRA, they are governed by the same rules that govern other Retirement Accounts of the spouse. The spouse's age determines when the RMDs must start. The spouse computes the RMDs using the Uniform Life Table, which allows slower distributions than the Single Life Table. There will be early withdrawal penalties if the surviving spouse withdraws assets prior to the time the spouse attains age 59 ½, regardless of the age of the account owner spouse at death.
• Treat the Retirement Account as the Spouse's Own. Rather than rolling the assets to the spouse's own IRA, the spouse can elect to treat the decedent's Retirement Account as the spouse's own account. In that event, the treatment is the same as if the spouse had rolled the account over. Note that not all qualified plans will permit this (and thus a rollover could be required).
• Treat the Retirement Account as the Decedent's Own. If an account owner dies before their required beginning date for RMDs, new proposed regulations provide that the surviving spouse may elect to treat the Retirement Account as the deceased account owner's account. In that event, the spouse need not withdraw RMDs until the deceased account owner would have attained the age when RMDs must begin.² The surviving spouse will compute RMDs using the Uniform Life Table and the surviving spouse's age. Note that the regulations treat the Retirement Account in these circumstances as an inherited account that is not subject to a penalty if the surviving spouse withdraws assets prior to attaining age 59 ½.

How does a surviving spouse choose among these options? There are several factors to consider. Did the deceased Retirement Account owner die before or after the required date for beginning RMDs? How old is the surviving spouse? If the surviving spouse is younger than 59 ½, do they need or want access to the Retirement Account assets before they attain 59 ½? Does the surviving spouse anticipate living beyond their statutory life expectancy?

A surviving spouse who has not yet attained age 59 ½ and who needs or wants to have access to the Retirement Account assets before that time should not roll the assets over to their own IRA or treat the Retirement account as their own, as withdrawals before age 59 ½ will be subject to penalty in addition to tax. In this situation, the spouse is better off choosing an inherited IRA. If the deceased spouse died before reaching the beginning date for RMDs, the spouse may consider electing to treat the account as belonging to the decedent, in which case the RMDs are computed using the spouse's age and the Uniform Life Table.³ Using the Uniform Life Table instead of the single-life table results in smaller RMDs and can make the assets last longer if the spouse anticipates outliving their statutory life expectancy. No penalty will be applied to withdrawals before the spouse attains age 59 ½.

A surviving spouse not concerned about pre-59 ½ access is generally better off rolling the Retirement Account over to their own IRA or treating the decedent's account as the spouse's own. This gives the spouse the Uniform Life Table for computing RMDs, and those are based on the spouse's age. However, where the deceased spouse was significantly younger than the surviving spouse, the surviving spouse may be able to defer the taxation longer by electing to treat the account as belonging to the decedent spouse. In that case, even if the surviving spouse is over 75, they will not need to start RMDs until the deceased spouse would have attained that age.

A decision whether to roll the Retirement Account to the surviving spouse's own IRA or to treat the decedent's account as the surviving spouse's account typically depends on whether the assets are in a qualified plan or an IRA and what the investments are. There can be differences in the expense of maintaining the account, and the breadth of investment options may depend on the type of account. These options are available when the account owner names their spouse directly as the Retirement Account beneficiary. If an account owner names a trust as the beneficiary of the Retirement Account – even if that trust is solely for the benefit of the surviving spouse – the options are limited and will depend upon the terms of a trust.

• If the account owner names a withdrawal marital trust as the beneficiary of the Retirement Account, giving the surviving spouse the unilateral right at any time to withdraw all the assets of the trust, there are two options. The trust can create an inherited IRA to receive the assets, or the spouse may roll the assets over into the spouse's own IRA. Note that withdrawal marital trusts are not common since the introduction of the Qualified Terminable Interest Property (QTIP) marital trust in the 1980s.
• If the account owner names a QTIP marital trust as the beneficiary of the Retirement Account, the options are more limited. If the trust terms require the trustee to withdraw all the RMDs and pay them to the surviving spouse, the trust may qualify as a conduit trust, which is good news. If the surviving spouse is the sole beneficiary of a QTIP conduit trust named as the beneficiary, then the trust can elect to treat the Retirement Account as the decedent's own, defer RMDs until the decedent would have attained age 75, and calculate them using the surviving spouse's age and the Uniform Life Table. Otherwise, the only option is for the trust to create an inherited IRA. Note that a QTIP election is required both for the trust AND for the Retirement Account.
• The option above is only available if the plan permits life expectancy payout. If the plan requires using the 10-year rule or allows the beneficiaries to elect to use the 10-year rule, then that will govern – even if the beneficiary is a conduit trust. (Compare this with the ability of a surviving spouse named as the direct beneficiary to roll the assets to their own IRA to avoid the application of the 10-year rule).
• If the beneficiary of the Retirement Account is a trust that does not require the trustee to distribute all RMDs in full each year, the accumulation trust rules apply. Depending on the terms of the trust, the surviving spouse may be able to compute RMDs based on the surviving spouse's life expectancy. Otherwise, the 10-year rule, or one of the more limited fixed number of years rules such as the 5-year rule or the “at least as rapidly rule,” may apply and curtail the continued tax deferral status of the Retirement Accounts.