This is the second in a series of posts about Ideal Roth Conversion Candidates.  See the first post, Low or Zero Tax, at this link.

One of the planning options that most all folks have available to them is the Roth IRA Conversion.  For the uninitiated, a Roth IRA Conversion is a transaction where you move money from a Traditional IRA or a Qualified Retirement Plan (QRP) such as a 401(k) into a Roth IRA.  With this transaction, if any of the funds in the original account was pre-tax, that amount would be included in income as potentially taxable in the year of the Conversion.

As you might expect, making a decision like this can result in a considerable tax impact, depending on the individual circumstances.  A Roth IRA Conversion may make a great deal of sense for one individual, while another may decide that the Conversion cost is too great for the result.  Detailed below is one specific circumstance that indicates a Roth IRA Conversion is a good move – although each individual needs to consider his or her situation carefully, because every situation is unique.

Protecting Non-Taxation of Social Security

In this situation, the individual has a very low taxable income, low enough that she would not likely need to include Social Security benefits as taxable income, once she begins receiving the benefits.  However, once she reaches age 70½ and Required Minimum Distributions (RMDs) are necessary, the amount of these distributions will increase her overall provisional income to a point where Social Security benefits will be taxable at the fullest rate, 85%.  Converting a portion of the IRA to Roth IRA will help to keep the RMDs low enough that SS benefits can be taxed at a lower (or zero) amount.

For example, Jane is 60, single, and has retired.  She intends to begin receiving Social Security benefits of $24,000 at her full retirement age of 66.  She needs a total of $40,000 each year to live on.  She presently withdraws that amount from her IRA on an annual basis.  Her IRA balance at this point is $600,000.

If she did nothing about converting to Roth, when she reaches 70½ the amount of her RMD will be large enough to bump up her provisional income to a point where her Social Security benefits will be taxable at the maximum 85% rate. This comes about because her balance in the IRA (after withdrawals and annual increases averaging 5%) is roughly $557,000 at her age 70½.

If, however, Jane began a process of converting a small portion of her IRA to Roth IRA each year between now and when she reaches age 70½, she could reduce the size of her traditional IRA and therefore reduce the size of her future RMDs to a point where the tax impact on her SS benefits is eliminated.  In our example, if Jane withdrew an additional $15,000 from her IRA and converted the after-tax portion to a Roth IRA, this would reduce her IRA balance to a point where the RMD (when required at age 70½) would be low enough that her SS benefits would no longer be subject to taxation at all.

This series of conversions brings her Traditional IRA balance down to approximately $359,000.  At the same time, she has amassed a Roth IRA with a balance of approximately $148,000 – so her total of the two accounts is approximately $507,000.  The tax cost of the conversions and the lost income/appreciation on the money used for taxes makes up the difference.

This conversion would cost her an additional $3,750 per year for ten years, but the effect of non-taxation of her future SS benefits would be a reduction in future tax of $5,100 – for the rest of her life.  With this in mind, approximately 10 years later, at her age 80, this strategy would have paid off.  If she died prior to that age, the Roth Conversion would have cost more than the benefit.

Note: the figures used in the examples do not include inflation, and are purposely rounded for simplification.  Real-world results will differ, perhaps significantly, from this example.

Conclusion

There are many other situations when a Roth Conversion makes a lot of sense, the above is one example of a very good scenario for the conversion.  As I mentioned previously, each individual’s situation will be different and may or may not result in the same decision to convert or not.  Watch for more examples in future posts!

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

One of the planning options that most all folks have available to them is the Roth IRA Conversion.  For the uninitiated, a Roth IRA Conversion is a transaction where you move money from a Traditional IRA or a Qualified Retirement Plan (QRP) such as a 401(k) into a Roth IRA.  With this transaction, if any of the funds in the original account was pre-tax, that amount would be included in income as potentially taxable in the year of the Conversion.

As you might expect, making a decision like this can result in a considerable tax impact, depending on the individual circumstances.  A Roth IRA Conversion may make a great deal of sense for one individual, while another may decide that the Conversion cost is too great for the result.  Detailed below is one specific circumstance that indicates a Roth IRA Conversion is a good move – although each individual needs to consider his or her situation carefully, because every situation is unique.

Low (or Zero) Tax Rate

If an individual is in a situation with a very low tax rate, a Roth Conversion could be a good idea – especially if the situation with the low tax rate is due to change in the future.

An example would be if Joe, a 30-year-old, finds himself taking a year off to go to school and pick up the last few hours of his Master’s degree.  Joe has had a good career in sales for the past several years, and he put $100,000 into his former employer’s 401(k) plan.  The account grew to $150,000 by this year, when Joe has started going to school, intending for his Master’s degree to allow him to advance further in his career.  Joe also has a fairly significant taxable investment account, some of which he plans to use for living expenses, but he also has some extra money in the account which could be used to pay taxes on a Roth Conversion.

Since Joe supports himself and he is a single filer, he should consider converting a portion of his 401(k) account (all pre-tax money) to a Roth IRA.  This is because, having no other income for the tax year, the first $9,750 of income that he claims on his tax return will have zero tax (for 2012) because of the standard deduction and personal exemption.  After that, his next $8,700 of income claimed is taxed at 10%, for a tax cost of $870 for a total conversion of $18,450 – an effective rate of 4.7%.

He could further convert up to an additional $26,650 at the 15% rate, for a total converted amount of $45,100.  The total tax cost of his conversion would be $4,868, for an effective tax rate of only 10.8%.  Taking this a step further, the 25% tax rate would be used for up to $50,300 more of conversion.  This would result in a total of $95,400 being converted, and a total tax of $17,443 – for an effective tax rate of only 18.3%.

Since Joe expects that his income in the future will be much higher – into the six-figures category, it probably makes sense for him to convert as much as possible in these lower tax brackets while his income is actually zero for the year.  Even though it will cost him $17,443 from his taxable account to pay the tax, this is a far lower rate than he could expect to pay on withdrawals from this account in the future.

It should be noted that one of the very important factors in this scenario is that Joe has other funds from which to pay the tax.  If he didn’t have this money available from a source other than his IRA, a portion of the IRA would have to be used to pay the tax.  This would result in imposition of the 10% early withdrawal penalty in addition to the tax on the distribution.  The additional cost of this distribution would weaken the position and increase the overall cost of the conversion.

Conclusion

There are many other situations when a Roth Conversion makes a lot of sense, the above is one example of a very good scenario for the conversion.  As I mentioned previously, each individual’s situation will be different and may or may not result in the same decision to convert or not.  Watch for more examples in future posts!

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

If you’ve paid much attention to the rules around retirement plans (IRAs, 401(k)s, and others), you’ve probably noticed that there are a couple of rules that refer to ages that include “½”.  So what does this mean??

Well, quite literally, this means 6 months after you reach a certain age.  The two primary ages with “½” included are 59½ and 70½.  So, to be age 59½, means that you reached your 59th birthday six months prior to that date.  Likewise, to be age 70½ means that you reached age 70 six months prior to that date.

These two ages are for different purposes and are (naturally) treated differently.

Age 59½

The rule using age 59½ is for one of the exceptions to the penalty for early withdrawals from your IRA or 401(k) plan: once you’ve reached that age (and not before that age) you can take withdrawals from your IRA or 401(k) plan without limits (401(k) plans may also require a separation from service).

Here is an important point: this rule is specifically applied ONCE YOU REACH AGE 59½, and not before.  In the year that you will reach this age, any withdrawals taken from the account before you reach age 59½ will be subject to the 10% penalty if no other exceptions apply.

Age 70½

The rule using age 70½ is regarding Required Minimum Distributions (RMD), as well as limiting contributions to an IRA.  For RMDs, the requirement is simply that you must begin taking the required distributions for the year in which you’ll reach age 70½.  (You can actually delay the first distribution until April 1 of the following year, but the distribution is based on the year when you reach age 70½.)

Note that this is different from the way the 59½ rule works: it’s simply the year in which you’ll reach age 70½, not the specific date that you reach age 70½.  So if your birthday is between January 1 and June 30, your age 70½ year is the year that you reach 70 years of age.  If your birthday is between July 1 and December 31, your age 70½ year is the year that you’ll be reach 71 years of age.

The same holds true for contributions to an IRA: in the year that you’ll reach 70½, you are not allowed to make contributions, and you are not allowed to make contributions thereafter.

You Don’t Have to Count Days

The good news is that you don’t have to count days.  For the purposes of these rules, the half year is the same date, six months later.  For a birthdate of May 11, the half year is reached on November 11 of that same year.  For odd circumstances, such as August 31, of course you’ve reached the half year on February 31 of the following year.  Actually, I believe the rule is that you reach that milestone on March 3 – I’d use this date if you are in this situation, just to be certain.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

The Social Security Administration trustees recently projected the wage base for 2013.  This is the maximum amount of wage income that an individual earns for the year that is subject to Social Security withholding tax.  For 2013, this amount is projected at $113,700.

The new amount is $3,600 more than the 2012 wage base, which is set at $110,100, for an increase of 3.27%.  Keep in mind that this is only the increase in the taxed wage base, and there is little correlation between this and any potential increase in benefits for the year.

Future years’ estimated wage bases are projected as follows:

2014: $117,900

2015: $123,000

2016: $128,400

These are only projections, each year in October the SSA trustees will set the amount for the coming year.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

As you begin a new job, or if you are a longer-term employee who is just starting to make contributions to a 401(k) plan, you are confronted with a question:  How does a contribution to the 401(k) plan impact the final take home pay on my paycheck? Believe it or not, you could actually increase your bottom line assets by reducing your income through a 401(k) contribution.

Let’s work through an example so that we can more completely understand what happens.

Your New Job

So, you’ve started a new job, with an annual pay of $30,000.  We won’t go into all of the details behind a W4 at this point, but for the sake of the example, we’ll say you filed your W4 to exactly match your tax expected of $2,603 for the year (and you started in January).  In addition to this, you have opted to take advantage of your employer’s health insurance plan, which costs $50 per month.  You are paid on an every-other-week schedule, for 26 pay periods per year.

This means that your take-home pay amounts to approximately $884.82, which is calculated as follows:

Your 401(k)

So, you now are ready to begin making contributions to your available 401(k) plan.  The company will match your contributions as follows:

100% of the first 2% of contributions

50% of the next 2% of contributions

25% of the next 2% of contributions

If you make a total of 6% in contributions, the company will match that with 3.5% contributed to your account.  Your 6% of $30,000 will amount to $1,800 per year, and the company match will be an additional $1,050, for a total contribution of $2,850.

For each paycheck, you are making a contribution of 6%, which is $69.23, and the company’s match is an additional $40.38 added to your account.  The result in change to your paycheck will work out as follows:

The difference in your final take-home pay is only $55.48, which is $13.75 less than the amount that you contributed to the 401(k) account.  This is due to the fact that when you make a contribution to the 401(k) account, this amount is no longer subject to income tax.

When you consider what your overall economic result from this new paycheck is, you’ll see that making the 401(k) contribution is, indeed, a no-brainer:

As you can see, the end result is that you actually have increased your overall money on your balance sheet assets by $54.13, which is a 6.11% increase.  Granted, your 401(k) account and the company match are restricted in access, but your overall situation is a significant increase.

Keep in mind that, while we used 401(k) as the example type of account, the same could apply to a 403(b), or other sort of tax-deferral account.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

When you don’t file your tax return or if you don’t pay the tax owed on time, the IRS has specific penalties that are applied to your account.  Recently the IRS issued their Tax Tip 2012-74, which lists eight facts about these penalties.  The actual text of the Tax Tip is listed below:

Failure to File of Pay Penalties: Eight Facts

The number of electronic filing and payment options increases every year, which helps reduce your burden and also improves the timeliness and accuracy of tax returns.  When it comes to filing your tax return, however, the law provides that the IRS can assess a penalty if you fail to file, fail to pay, or both.

Here are eight important points about the two different penalties you may face if you file or pay late.

1. If you do not file by the deadline, you might face a failure-to-file penalty.  If you do not pay by the due date, you could face a failure-to-pay penalty.
2. The failure-to-file penalty is generally more than the failure-to-pay penalty.  So if you cannot pay all the taxes you owe, you should still file your tax return on time and pay as much as you can, then explore other payment options.  The IRS will work with you.
3. The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late.  This penalty will not exceed 25 percent of your unpaid taxes.
4. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.
5. If you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid.  This penalty can be as much as 25 percent of your unpaid taxes.
6. If you request an extension of time to file by the tax deadline and you paid at least 90 percent of your actual tax liability by the original due date, you will not face a failure-to-pay penalty if the remaining balance is paid by the extended due date.
7. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty.  However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.
8. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

As reviewed in the article The Family Maximum Benefit (Retirement), there is a maximum amount that can be paid on a particular Social Security record.  As you’re planning for your family’s benefits, it is important to know what is involved in establishing the maximum benefit, as well as what can be impacted by the maximum limit.

What’s Not Included

Maybe it would be easiest to point out a few things that don’t go into the calculation for the Family Maximum limit:

• Ex-spouse spousal benefits are not included
• Ex-spouse survivor benefits are not included
• Any delayed retirement credits on the primary beneficiary’s record are not included

So – with those items excluded, that leaves us with the question of what IS included:

What Is Included

Included in calculating the Family Maximum benefit limit would be everything else that wasn’t specifically excluded, based upon the primary recipient’s record:

• Primary beneficiary’s benefit, up to the Primary Insurance Amount
• Spousal Benefits for a current spouse (not an ex)
• Survivor Benefits for the spouse who was married to the primary beneficiary at the date of death
• Child’s benefits
• Spouse benefits for a spouse caring for young children under age 16
• Other beneficiary benefits, including aged parents, other dependents, etc.

What Can Be Impacted by FMB

Once the Family Maximum Benefit amount is calculated, certain benefits can be reduced as a result (if the maximum is breached).  First of all, it’s important to note that those benefits mentioned in the “What’s Not Included” section above are not subject to reduction by the FMB.  In addition, the primary beneficiary’s retirement or disability benefit would also not be reduced by a limit imposed by FMB.

All of the other, secondary benefits, such as survivor benefits by the last-current spouse, spousal benefits, child’s benefits, and other beneficiary benefits can be reduced.  Each benefit is reduced pro-rata depending on the FMB figure that has been developed.

Example

So let’s work through an example: John, age 70, just filed for his retirement benefit, in the amount of $3,000.  His Primary Insurance Amount (PIA) is $2,273.

John was married twice previously, to Jane first (age 62) and then to Sally (age 63), and each of those marriages lasted more than ten years.  He married his current wife, Celeste (age 30), three years ago and they have newborn triplets.

The family maximum benefit is calculated as follows (2012 figures):

1) 150% of the first $980 = $1,470

2) 272% of the next $435 = $1,183

3) 134% of the next $430 = $576

4) 175% of the remaining PIA ($428) = $749

5) adding these up ($1,470 + $1,183 + $576 + $749) = $3,978 <= this is the FMB limit for John’s record

Now, we know that Jane’s spousal benefit and Sally’s spousal benefit are not included in the FMB.  Additionally, John’s Delayed Retirement Credit ($727) is also not included.  The following benefits are included in determining if the FMB has been reached:

John’s PIA of $2,273

Celeste’s benefit for caring for the children of $1,136 (half of John’s)

Each child’s benefit of $1,136 (x3 = $3,408) (also half)

For a total of $6,817, which is $2,839 more than the FMB.  Since John’s PIA amount cannot be reduced, Celeste’s and the childrens’ benefits will be reduced at a rate of 58% less than their original amounts – to $477 for each of the benefits.  (That calculation was done by taking the full FMB, subtracting John’s PIA, and then splitting up the remaining amount pro rata among the other beneficiaries.)

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

I thought it might be helpful to work through an example of an IRA that has been inherited by multiple beneficiaries, so that we can discuss the important components of working with such a situation.

In our example, we’ll say there is an IRA worth $800,000 at the date of death of the original owner, and she has designated four beneficiaries of the account.  One of the first factors that is important to note is that the beneficiaries could be anyone – they do not have to be related to the original owner, or likewise they could be the children, grandchildren, nieces, nephews, brothers or sisters of the original owner.  For the purpose of this example though, none of the beneficiaries is the surviving spouse of the original owner – surviving spouses have different rules to work from.

Option 1 – Do Nothing

The beneficiaries of the original account could choose to make no changes to the account, leaving it exactly where is was during the life of the original owner. Assuming that the original owner was not subject to Required Minimum Distributions (that is to say, the original owner was not age 70½ or older), the account will be distributed over the lifetime of the oldest of all the beneficiaries, in equal shares to each of the four.  Table I, Single Life Expectancy, is used to determine the amount of the distribution, and the age is the age of the oldest beneficiary. (If the original owner was subject to RMD, the beneficiaries have the option of using her lifespan instead of the lifespan of the oldest beneficiary if this would result in a longer payout period.)

This option results in the least amount of “moving parts” and is likely the simplest to implement, but as we all know, getting four people to agree on things like how to manage the account, what investments to make, etc., is a difficult task.  This option also requires the younger beneficiaries to take distributions of larger amounts than would be required if the account were distributed over their own, longer, life span.

Option 2 – Separate Accounts

The beneficiaries of the IRA account have the option of splitting up the account into equal shares of the original account.  In this fashion, each individual would own an account, titled as “inherited” so that there’s no misunderstanding – the account is inherited, not a regular IRA (more on this later).

Once the separate accounts are set up, each of the four beneficiaries is allowed to (actually required to) take distributions over his or her own lifespan, rather than all being required to take distributions over the oldest beneficiary’s lifespan as was the case in Option 1.  In addition, each beneficiary can now make the investment and management decisions about the account separately.  The individual beneficiary should now also designate a beneficiary for any amount that is remaining in the account when the individual beneficiary dies.

Important Points

A few points that are very important to note here:

• The separate accounts are the property of each individual beneficiary, but the account must retain a title which clearly designates the account as inherited.  Since the account is inherited, the owner of the account cannot make contributions to the account, roll it over into another IRA account, or convert the account to a Roth IRA.
• When creating the separate accounts, it is important to ensure that the transfer is a trustee-to-trustee transfer.  If the funds are removed from the account (as in a 60-day transfer) then contribution back into an IRA is not allowed, and the amount distributed is no longer considered to be an IRA.
• The separate accounts must be established by December 31 of the year following the year of the death of the original owner.  If not established by this date, then Option 1 is the default, and now only, option available.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

Remember way back in 2011, when the Social Security Administration used to send you a paper statement every year?  This was a useful statement, which included the estimates of your future benefit at age 62, full retirement age, and age 70, as well as a run-down of your year-by-year earnings information.  Ah the good ol’ days…

Sometime in 2011 the SSA stopped mailing those statements, and instead made available on their website a series of calculators which would give you your Primary Insurance Amount (the amount you’d receive at Full Retirement Age) estimate, but little else.  This calculator was nowhere near as useful, and lots of folks were upset about it.

Well, apparently someone at SSA listened, because now there is a new option on the SSA website, at www.socialsecurity.gov/mystatement, where you can create an account and receive essentially the same information that was previously available on the paper statement – including earnings history!  How about them apples??

But that’s not all…

I have also have it on good authority from a source within SSA that the paper statements will be coming back.  Only for folks age 60 and older, but hey, that’s who really needs this information anyhow, so this is great!

Great job, Social Security!

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

When the owner of an IRA dies and leaves the IRA to his or her spouse as the sole beneficiary, there are some unique options available for handling this inherited IRA.  Keep in mind that these options are only available to a spouse a beneficiary – a non-spouse beneficiary has much more limited options available.

Options for a Spousal Beneficiary of an IRA

The first and easiest option is for the spouse to leave the IRA exactly where it is and do nothing.  In this manner, the IRA will continue to exist as belonging to the deceased spouse – for a time.  If the deceased spouse was over age 70½ years of age and subject to Required Minimum Distributions (RMDs), the surviving spouse could elect to continue receiving those RMDs using his or her late spouse’s lifetime as the distribution factor.

On the other hand, if the deceased spouse was not subject to RMDs, the surviving spouse could also begin receiving RMDs from the inherited IRA based upon his or her own age.  This is a viable option as well.

On the third hand, after leaving the IRA in the name of the deceased spouse the surviving spouse could also opt to not take RMDs from the account at all – in this case the inherited IRA would be considered to be owned by and controlled by the surviving spouse, no longer an inherited IRA.  If the surviving spouse is over age 70½, he or she will need to begin receiving RMDs from the account based on his or her age.

Another option available to a spousal beneficiary of an IRA is to rollover the account into an IRA in his or her own name.  This would give the surviving spouse the same result as the “third hand” mentioned above.

In other words, both of these last two options results in the IRA being treated as if it was owned by the surviving spouse.  He or she is eligible to make contributions to the account, take withdrawals if over age 59½ (or if one of the exceptions applies) without penalties, rollover the account to another IRA or Qualified Retirement Plan, and convert the account to a Roth IRA.

Why Would the Spouse Choose One Option Over Another?

In some instances, it could be advantageous to leave the IRA in the name of the deceased spouse.  For an example, let’s say Jane died leaving John (her husband) as the sole beneficiary of her IRA.  Jane was 70 years old and not yet subject to RMD, but eligible for penalty-free distributions.  John is 57 years old, and as such he’s not yet eligible to take IRA distributions from a regular IRA in his own name.  Once the time has passed when Jane would have reached age 70½, John will be subject to RMDs from the account based upon Jane’s age (since it’s still in her name) but if he needs the income he has it available without penalty.  If he rolls over the account to his own name at age 57 he will not have penalty-free access to the funds for 2½ more years.

So, leaving the account in Jane’s name will allow John to take withdrawals from the account without penalty.  Once John reaches age 59½ he can rollover the account to an account in his own name, which will allow him to name beneficiaries of the account on his own (otherwise the original beneficiary designations that Jane made are still controlling the account).

Another situation that might make sense for the surviving spouse to leave the account in the name of the deceased spouse is if the surviving spouse is older.  From our example, if Jane and John’s ages were switched (Jane, the deceased was 57 and John is 70) then John could benefit from leaving the account in Jane’s name. This is because he could take distributions from the account without penalty (death benefits are penalty-free) without being required to take distributions (when he reaches 70½).

At the point in the future when Jane would have been age 70½, John could rollover the IRA into an account in his own name, again so that he can name his own beneficiary for the account.  This way he didn’t have to take RMDs until that point.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
Post from: Getting Your Financial Ducks In A Row

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