The Surviving Spouse’s Rollover

A few posts ago I began a description of the Required Minimum Distribution rules. I want to round that out by describing how they operate after your death. As if you care at that point.

But before getting into the details, which I will do in tomorrow’s and the next day’s posts, I suggest that you think about the post-death RMD rules as only applying after the death of both you and your spouse. You can think of yourselves as a single economic unit, because that’s how the drafters of the Tax Code thought of you when they made up these rules.

When it comes to your tax-favored retirement accounts, the Tax Code has created a mechanism for the surviving spouse to roll over the deceased spouse’s retirement account into an IRA of her own (or into an employer plan, if the surviving spouse’s employer’s plan accepts such rollovers). This type of rollover is available whether the deceased spouse’s account was a 401(k) plan account, a traditional IRA, a Roth IRA or any other type of tax-favored retirement account. And, for the most part, it’s only available to a surviving spouse—not to the kids, not to domestic partners, just opposite sex surviving spouses. (I’ll discuss a partial exception to that statement in tomorrow’s post.)

Here’s a few ground rules. First, for the surviving spouse to be able to take advantage of this, she must be named as beneficiary of the account. No surprise there. The surviving spouse can’t do anything with the account unless she’s entitled to it, and she’s only entitled to it by virtue of being named beneficiary.

In any case, this is how most people do it: “If I die [what’s with this “if”?], all to my Wife. But if she has predeceased me, then to my kids.” Where you often see something more complex is in second marriages, where each spouse wants to be sure the account is not diverted to the second spouse’s kids from a different marriage. Then they might name a trust of some sort as beneficiary, in which case there’s no opportunity for the surviving spouse to do a rollover, even if she is a beneficiary of the trust. But I digress.

The second ground rule relates to Roth-ness. If the deceased spouse’s account is a Roth IRA or Roth 401(k), the surviving spouse can roll it over into a Roth IRA. If it’s a traditional pre-tax account, the surviving spouse can roll it over into a traditional IRA. In this way, the account retains its character as either a Roth account or a traditional account. So the family doesn’t end up either double taxed or avoiding income tax. Makes sense.

The third ground rule is that for the rollover to be available, the surviving spouse must be entitled to get a distribution from the deceased spouse’s account. That’s never a problem with IRA’s. It’s almost never a problem with employer plans either, but it might be. It’s conceivable that the deceased spouse’s employer’s plan says, for example, that upon his death, distributions must be spread out in annual installments over more than 10 years. In that case, a rollover would not be available to the surviving spouse. But such a provision would be unusual.

Once the surviving spouse has met the ground rules, she can roll over the tax-favored account into an IRA of her own. Then here’s what happens. It’s like her spouse’s death was a non-event for tax and retirement plan purposes:
• No income tax just yet
• Continued tax exemption on investment earnings within the account
• Surviving spouse gets to control the investments
• Surviving spouse gets to control the rate at which distributions are taken (subject to the Required Minimum Distribution rules)
• Surviving spouse gets to name her own beneficiary (the kids, presumably) in the event of her death
• Required Minimum Distributions don’t begin until surviving spouse reaches age 70-1/2
• Once surviving spouse reaches age 70-1/2, RMD’s are based on her age and beneficiary, not the deceased spouse’s age
• If surviving spouse is not yet 59-1/2, distributions to her will be subject to a 10% penalty unless an exception applies (summarized in February 19’s post)
• Surviving spouse can do further rollovers, for example if she wants to change the institution where her retirement funds are invested

As you can see, for the surviving spouse, your spouse’s death can be a non-event. At least in retirement plan world if not in real life.

More about death tomorrow. Then with that as background, I can describe the RMD rules as applied to the non-spouse beneficiary after the death of the retirement account owner.