A surviving spouse who inherits an IRA has a choice. He/she can move the account into an inherited IRA to keep the tax deferral. Or she can choose to roll the account into her own IRA. The decision typically hinges on whether the surviving spouse has turned 59 1/2 and whether her spouse had turned 70 1/2 before he died.
A spouse who is younger than 59 1/2 and needs the money would be better off remaining a named beneficiary. If she rolls the money into her IRA and then withdraws any of it, she'll pay a 10% penalty until 59 1/2. Instead, if she remains a beneficiary, she can tap the account without penalty. To be a named beneficiary, she must retitle the account as an inherited IRA.
But she's no locked into that option. At any time, she can roll the money to her own account.
A surviving spouse who is younger than 70 1/2 and doesn't need the money generally should make the IRA her own. She won't be required to make minimum distributions until she turne 70 1/2.
Say a 74 y.o. husband dies and passes his $500,000 IRA to his 64 y.o. wife. If she takes it as her own, she can wait 6 years to take distributions. At 74, his required minimum distribution would have been about $21,000, according to Charles Schwab's Beneficiary RMD Calculator. When she turns 70 1/2, her first RMD will be about $25,000, and the account will have climbed to nearly $700,000 (assuming a 6% annual growth rate).
The age of the account owner at death also could influence a surviving spouse's decision. If the owner died before the date she was required to begin distributions, a spouse who remains a beneficiary will not have to take distributions until the year that her late spouse would have turned 70 1/2. (Note: the "required beginning date" for taking distributions is April 1 of the year after the owner turns 70 1/2.)
Assume a 64 y.o. wife leaves a traditional IRA worth about $530,000 to her 74 y.o. husband, and he keeps it as an inherited IRA. Six years later, when his wife would have turned 70 1/2, he takes his RMD of about $70,000, based on his own life expectancy. At 90, he would have about $300,000 in the account.
If instead he takes the account as his own, he will take his first distribution at age 75. He'll have to withdraw about $23,000. Although he has to start distributions much sooner, the RMDs are smaller and the account will last longer (assuming a 6% annual return). At age 90 he would still have about $512,000.
If a late spouse had already started distributions, a survivor who stays a named beneficiary can use either her own life expectancy or her spouse's. If the survivor is older, she might choose the late spouse's because it would be the longer of the two life expectancies.
A survivor's decision to roll the IRA into her own or keep it as an inherited IRA can have a big impact on the next generation. If the IRA becomes your own, your beneficiaries can use their own life expectancies to take distributions when they inherit the money. Your beneficiaries can also stretch distributions over their lifetimes if you kept the acount as an inherited IRA but before your deceased spouse would have turned 70 1/2. (Learn more about how to prevent beneficiaries from blowing the stretch-out when they inherit by using our IRA Inheritance Trust.)
But if you kept the account as an inherited IRA and you die after you start RMDs, your beneficiaries will have to take RMDs based on the life expectancy you were using. That means your younger beneficiaries will have lost the chance to stretch the IRA over their lifetimes.