Back to Missives
George F. Bearup, J.D. Senior Legal Trust Advisor

November 1, 2022

IRA Beneficiary – The Surviving Spouse’s Choices: The Rollover Option

Take-Away: Tax deferral is best accomplished when a surviving spouse decides to roll over their deceased spouse’s IRA to the survivor’s own IRA.

Background: A very common situation is that an individual dies naming his or her surviving spouse as the designated beneficiary of their  IRA. The surviving spouse  has essentially three choices to make with regard to the decedent’s IRA.

  1. Deemed Election to Treat as Own IRA: One choice is to do nothing. This called a deemed election that results from inaction. The effect of a deemed election is the same as rolling the decedent’s IRA into the survivor’s own IRA, possibly without triggering some of the limitations of a rollover, e.g. the one rollover in a 365 day period. [IRC 408(d)(3)(B).] However, this option comes with a new ‘deadline’ created by the SECURE Act’s Proposed Regulations. (More on that new deadline later in another missive.)
  2. Inherited IRA: With this option the surviving spouse will be treated as the beneficiary of the decedent’s IRA. There are two special required minimum distribution (RMD) rules that apply but only to a surviving spouse who is the designated beneficiary of the decedent’s IRA: (i) an annual redetermination of the survivor’s life expectancy; and (ii) a delayed commencement of the survivor’s RMD if the decedent IRA owner died young. This option can be a helpful when the surviving spouse is relatively young. If the survivor is younger than age 59 ½, the survivor can immediately access the funds held in the inherited IRA without incurring a 10% ‘early distribution’ penalty, because the inherited IRA is not the technical owned by the survivor. Importantly, in this situation, the survivor can at any later point rollover all, or part, of the inherited IRA (other than an RMD) to his/her own IRA account. These flexible rules will also apply if the decedent left his or her IRA to a conduit trust of which the survivor is the trust beneficiary.
  3. Rollover to Own IRA: Most common, and perceived to be the best choice, is for the surviving spouse to simply roll all of the assets over from the decedent’s IRA to the survivor’s own Note that this choice can sometimes be used if the decedent’s IRA is payable to his or her estate, or to a trust, if the assets are distributed through that entity (estate or trust) to the surviving spouse.(See below.)  As noted above, a rollover by the surviving spouse can occur any time after the decedent’s death for any distributions (other than a required minimum distribution.) However, a spousal rollover is subject to the same tricky rollover rules as other IRA-to-IRA transfers, which means that the rollover is subject to the 60-day deadline and the once-every-365-day-rule.

Spousal Rollovers:  For purposes of this summary, let’s use as an example a married couple, Ben and Jeri. Ben dies and Jeri is the surviving spouse who must make a decision with regard to Ben’s IRA of which she is named its designated beneficiary. There are plenty of reasons why Jeri would consider a spousal rollover, and a couple of reasons why she might want to hold Ben’s IRA as a beneficiary of an inherited IRA, and only later pursue a spousal rollover. But first, some of the basic rollover rules.

Legal Authority for a Spousal Rollover: The rollover right is expressly given to Jeri with respect to benefits held in a qualified plan, like a 401(k) account. [IRC 402(c)(9).] Interestingly, the Tax Code with regard to an inherited IRA [IRC 408] is silent with respect to a Jeri’s rollover option. Indirectly, though, a spousal rollover of an inherited IRA is permitted by how an inherited IRA is defined in the Tax Code. [IRC 408(d)(3)(C).] The SECURE Act Proposed Regulations of this year make it clear that a spousal rollover of an inherited IRA is permitted by Jeri. [Proposed Regulation 1.408-8(d)(1)(ii).]

Tax Benefits of Rollover: In addition to the personal benefits of rolling Ben’s IRA to Jeri’s own IRA, including her complete control, her ability to name her own designated beneficiaries, and her own choice of investments, there are some obvious income tax benefits to Jeri making a spousal rollover.

  1. Delayed RMD: No distribution will be required from a rollover IRA to Jeri until she reaches age 72, since Jeri will be the owner of the rollover [IRC 408(a)(6).] For comparison purposes, if Jeri had continued as the beneficiary of Ben’s inherited IRA, as an eligible designated beneficiary, Jeri would have had to start taking RMDs by December 31 of the year after the year of Ben’s death. If Jeri is already age 72 she will have to start taking RMDs from her own rollover IRA. Note, too,  that this same special RMD rule can be used if Ben left his IRA to a conduit trust for Jeri’s benefit.
  2. Smaller RMDs, thus Longer Tax Deferral: Assume Jeri is age 72 when Ben dies. Jeri is required to take RMDs from her rollover IRA starting at age 72. However, Jeri’s RMDs are calculated using the Uniform Lifetime Table, which is based on the joint life expectancy of Jeri and a hypothetical 10-years-younger beneficiary, which RMD is redetermined annually. Thus,  Jeri’s RMD is not calculated using the Single Life Table, that would be based solely on Jeri’s own life expectancy. Had Jeri continued Ben’s IRA as an inherited IRA (i.e. no rollover ) then Jeri would have had to use the Single Life Table to calculate her RMDs. Consequently, by using the Uniform Lifetime Table to calculate her RMDs, Jeri’s RMDs each year will be smaller than would be the case had Jeri continued Ben’s inherited IRA as its beneficiary, rather than its

Comparison Example: (Inherited IRA) Assume that Jeri is age 78. Jeri is required to take an RMD from Ben’s inherited IRA. Under the Single Life Table which would be applicable had Jeri simply treated Ben’s IRA as an inherited IRA, 1/12.6th of the inherited IRA balance, or about 8% of that inherited IRA account, would have be taken as Jeri’s RMD for the year.

(Rollover IRA) Under the Uniform Lifetime Table which is applicable to Jeri’s rollover  IRA, her RMD at age 78 would be only 1/22nd of the rollover IRA account balance, or about 4.5% of the IRA balance. Consequently,  Jeri will benefit if she lives a long time and she takes no more than her RMD amount each year from the rollover IRA.

  1. Diminished (but still available) Deferral After Death: Upon Jeri’s subsequent death, distributions from her rollover IRA must be based upon Jeri’s choice of designated beneficiary. It is possible that Jeri might select as the designated beneficiary of her rollover IRA an eligible designated beneficiary, g. a disabled or chronically ill individual, or an individual who is less than 10 years younger than her. That choice of designated beneficiary could produce a longer payout from Jeri’s rollover  IRA if it was left as an inherited IRA to an eligible designated beneficiary. Obviously, the SECURE Act’s required maximum 10-year distribution rule for normal designated beneficiaries of an inherited IRA makes this potential deferral of taxes less likely to occur unless Jeri names an eligible designated beneficiary for her rollover IRA.

Comparison Example: (Inherited IRA) Ben dies in 2020 after the SECURE Act’s effective date. Assume Jeri, age 78, hold’s Ben’s IRA as an inherited IRA. Jeri takes annual RMDs over her life expectancy. Jeri dies in 2022 at age 80. Ben and Jeri’s two grandchildren (Jack and Jill) are the successor beneficiaries to the inherited IRA who were named by Ben. Jack and Jill take distributions in annual installments over what is left of Jeri’s life expectancy, or about 11.3 years, with a 100% distribution in the 10th year (2032) even though Jeri’s remaining life expectancy was a bit longer than 10 years. If Jeri dies after age 81, when her life expectancy is less than 10 years, Jack and Jill’s payout period from the inherited will be limited to Jeri’s remaining life expectancy, even though it was less than 10 years.

(Rollover IRA) Same facts as above, but Jeri made the choice to roll over Ben’s IRA to her own IRA. Jeri, due to her age, must take RMDs from her rollover IRA using the Uniform Lifetime Table that is used to calculate the RMD. Jeri dies in 2022 at age 80. Jeri chose to leave her rollover IRA to Jack and Jill as her own designated beneficiaries. Jack and Jill are subject to the SECURE Act’s 10-year distribution rule. Under the SECURE Act’s Proposed Regulations, Jack and Jill must take annual RMDs over their life expectancies for years 1-9, with a final 100% distribution in year 10 from Jeri’s rollover IRA. It appears that there is no advantage to the rollover IRA because whether Jeri holds Ben’s IRA as an inherited IRA, or as her own rollover IRA,  under either situation Jack and Jill will have to withdraw 100% of the IRA account balance no later than the year that contains the 10th anniversary of Jeri’s death. However,  there is still is a potential  deferral advantage to the rollover IRA, in spite of the mandatory 10-year distribution that applies in either situation. That is because with the rollover IRA, Jeri can take much smaller distributions during her lifetime as RMDs, so there will be substantially more deferral in her lifetime, and more assets that can be deferred by Jack and Jill over the following 10-year period before they must take 100% of the inherited IRA account balance.

In general, naming the surviving spouse as the designated beneficiary is a smart move from a  tax-deferral  perspective. The spousal rollover usually maximizes the potential payout period for the IRA even though after the SECURE Act that deferral period is not as good as it used to be.

Rollover Deadlines and Limitations: A spousal rollover is not a ‘minimum distribution’ rule. Consequently, the survivor’s rollover is not subject to various limitations that can arise under the other minimum distribution rules of the Tax Code. However, there are still several other ‘rules’ that must be followed by Jeri if she engages in a rollover of Ben’s IRA.

  1. Rollover at Any Time: Jeri does not have to be the sole beneficiary of Ben’s IRA in order for her to be able or roll over her portion of Ben’s IRA. [Proposed Regulations 1.408-8(d)(1)(ii) and (iii).] In addition, there is no requirement that Jeri’s spousal rollover occur within a specified period of time after Ben’s death. Jeri’s rollover could occur 5 or 10 years after Ben’s death. [Proposed Regulation 1.408-8(d)(1)(ii).]
  2. 60-day Rollover Deadline: If Jeri engages in a rollover from Ben’s IRA, it must occur no later than 60 days after the distribution was made to Jeri from Ben’s IRA. However, like any rollover, there might be exceptions to the 60-day deadline in which the assets from Ben’s IRA are placed into Jeri’s IRA. As is seemingly always the case, it is best to avoid a direct distribution to Jeri from Ben’s IRA, which then starts the 60-day ‘clock.’ Instead, it is better to make a custodian-to-custodian transfer of Ben’s IRA account, and avoid an actual rollover to Jeri, to avoid the 60-day deadline.
  3. Once Every 365 day Rollover Rule: This is one of those ‘gotcha’ rules that also applies to a spousal [Regulation 1.408(d)(3)(B).]Example: Ben dies on August 1, 2022. Jeri had previously completed a 60-day rollover between her two IRAs; the distribution that Jeri received was on July 15, 2022. Jeri would not be allowed to rollover a distribution from Ben’s IRA until after July 15, 2023. If Jeri relies instead on a custodian-to-custodian transfer of Ben’s IRA, that IRA-to-IRA transfer avoids the once-per-12-months limit. [Revenue Ruling 78-406.]
  1. Same Property Rollover Rule: Yet another ‘gotcha’ rule. If property instead of cash is distributed to Jeri from Ben’s IRA, Jeri must contribute to her rollover IRA the exact same property that she received from Ben’s IRA. Jeri cannot, for example, sell the property that she receives from Ben’s IRA while it is under her control, and then rollover to her own IRA the sales proceeds. The sales proceeds are not the same as the property that Jeri received from Ben’s IRA.
  2. RMDs Cannot be Rolled Over: This rule applies to all IRAs that are inherited if the IRA owner dies while subject to taking an RMD.Example: Ben was over 72 when the died. Thus, Ben was subject to taking an RMD from his IRA. Ben dies on August 1, 2022. However, Ben had not taken his 2022 RMD prior to his death. Ben’s RMD for 2022 was $45,000. Jeri must withdraw the $45,000 from Ben’s IRA and report it in her taxable income for the year; an RMD cannot be rolled over.. After Jeri takes Ben’s last RMD, only then can she roll over the balance of Ben’s IRA to Jeri’s own rollover IRA. Assume that Jeri overlooks this ‘last-RMD’ rule and she rolls over the entire balance of Ben’s IRA to her own rollover IRA. Now Jeri has made an excess contribution to her own IRA, subject to the 6% excise tax- the excess being Ben’s last RMD that Jeri should have reported in her 2022 taxable income. [Regulation 1.408A-4, A-6.] Fortunately Jeri can correct her mistake by withdrawing the erroneous amount (together with earnings on that excess contribution) from her rollover IRA by the due date of her own income tax return, to ‘fix’ this oversight, i.e. by April 15, 2023. [IRC 408(d)(4).]
  1. Rollovers Through an Estate or Trust: Assume that Ben names a trust as the beneficiary of his IRA. Jeri is the beneficiary of Ben’s trust. A spousal rollover may still be an option for Jeri. This option might also be available to Jeri if Ben died without naming a designated beneficiary, and the default beneficiary of Ben’s IRA was his estate. The spousal rollover is not an option that is available to Ben’s trust or Ben’s estate. Rather, only Jeri is entitled to roll over the distribution received from Ben’s IRA. Over a couple of decades of IRS private letter rulings it is possible for Jeri to roll over distributions from Ben’s IRA to Ben’s trust (or his estate) if she is entitled to receive the distribution from the trust or the estate, e.g. she has a right to withdraw the assets from the trust or the estate.Example: Ben’s IRA is payable to his trust. The trustee of Ben’s trust requires the trustee to pay the IRA to Jeri, or the trust instrument gives to Jeri the right to withdraw the IRA from Ben’s trust. The IRS has ruled on numerous occasions that Jeri is entitled to roll over the those distributions through Ben’s trust to her own rollover IRA.

    Example: Assume Ben failed to complete an IRA beneficiary designation prior to his death. The default beneficiary under the IRA custodial agreement is Ben’s estate. If  Jeri possesses the right to take assets, including the IRA, from Ben’s estate, e.g. Jeri is the residuary beneficiary of Ben’s estate,  Jeri can roll the IRA over to her own IRA through Ben’s estate.

    Example: Ben’s IRA is payable to his trust. The trustee of Ben’s trust may only make discretionary distributions to Jeri, the trust beneficiary, for her health support and maintenance. In this instance, since Jeri does not possess a right to receive assets from Ben’s trust. Accordingly,  Jeri may not rollover the IRA made payable to Ben’s trust to Jeri’s own IRA.

Conclusion: Next up will be a summary of a surviving spouse’s option to remain as the designate beneficiary of their deceased spouse’s inherited IRA. While that is an option, the tax deferral benefits associated with a rollover IRA will make the most sense for most married couples.