Surviving Spouse Options as Beneficiary

A Roth IRA is an individual retirement account named after the United States Congressman William Victor Roth Jr., who was the legislative sponsor of the bill creating this plan.

When a traditional IRA is converted to a Roth, all before-tax contributions made to the IRA become taxable; and the income tax must be paid. But once the money is in the Roth IRA, it grows tax-free; and the Roth IRA owner can make tax-free withdrawals at any time provided that five years have passed. For a Roth IRA, there are no minimum required distributions (MRDs) after you attain age 70½. This can be a tremendous advantage — tax-free growth and no minimum required distributions.

For estate planning purposes, transferring a Roth IRA to your beneficiaries on your death can be a very valuable opportunity. The beneficiary has an asset which will grow at a compounded rate tax-free for his/her lifetime, and any withdrawals made will be completely tax-free. There is simply nothing else like it. No other investment will give this kind of return tax-free. Inheriting a Roth IRA is much more valuable than inheriting any other asset. Note that the Roth IRA is still subject to Inheritance Tax and Federal Estate Tax at the owner’s death.

If you are the surviving spouse and named as beneficiary of your deceased spouse’s Roth IRA, you have four options:

1. Rollover your deceased spouse’s Roth IRA into your own Roth IRA.

   By using a spousal Roth rollover, the surviving spouse can avoid any requirements to withdraw funds from the account. One needs to keep in mind that withdrawals of earnings from a spousal rollover Roth IRA prior
   to age 59½ would be subject to the 10% early withdrawal penalty tax.

   A spousal rollover allows a surviving spouse to name primary and contingent beneficiaries to the IRA. This allows the surviving spouse, if the situation warrants, to correct any problems in the original beneficiary designations. Naming beneficiaries for the spousal IRA can provide these beneficiaries with the option of using their own life expectancies for drawing down the IRA once they inherit it.

2. Treat the Roth IRA as your own by designating yourself as the account owner, sometimes called “assuming” the IRA. If you assume the Roth IRA the IRS treats it as if it had always been yours. You don’t have to take any MRDs during your lifetime (if it was a traditional IRA you would have to start taking MRDs at 70½).

   Note: For the surviving spouse, the only difference between “assuming” the Roth IRA (2 above) or rolling it over into his or her own Roth IRA (1 above) is that for the 5-year period that assets must remain in a Roth for distributions to be “qualified” (tax free) if the account is “assumed”, then the holding period of the decedent can be added to the holding period of the surviving spouse in order to meet the 5-year requirement. Otherwise, there is no tax planning reason to choose a “rollover” over “assuming”.

3. Treat yourself as the beneficiary rather than treating the IRA as your own. If you own the account as beneficiary, then the Roth IRA must be distributed over the life expectancy of the original deceased owner for all beneficiaries who subsequently inherit the IRA. A spouse might choose this option if he or she is under the age of 59½ and has a clear and present need for the income from the Roth IRA. As beneficiary, the surviving spouse is required to take minimum distributions from the account. Withdrawals of earnings would be exempt from the 10% early withdrawal penalty tax.
4. Take a lump sum distribution. You may decide to take a lump-sum distribution and receive the proceeds of the Roth IRA outright. However, you’ll lose the tremendous benefit of tax-deferred investing that was the point of making the Roth IRA in the first place. If the contributions were in the Roth for 5 years, then the distribution will not be taxable to you; but you will not be able to continue the Roth for yourself or for the benefit of your beneficiaries.

If you choose option 2 above, there are three ways you as the surviving spouse can make the election to treat the Roth IRA as your own:

a. Affirmative election. Ideally, with proper advice and planning, the spouse makes the election by redesignating the account as an account in the name of the surviving spouse as IRA owner rather than as beneficiary.

b. Spouse contributes to the account. Another way to make the election is for the spouse to make a contribution to the account (other than a rollover of another retirement plan or IRA inherited from a deceased spouse). Since contributions (other than rollovers of other inherited plans from the same decedent) to an inherited IRA are not allowed, the spouse is deemed to have elected to treat the account as his or her own if he or she makes that type of contribution to it.

c. Failure to take an MRD. The third way to make the election is for the surviving spouse to fail to take, by the applicable deadline, “any amount” that is required to be distributed to him or her as a beneficiary under the Minimum Required Distribution rules.