How to navigate the rules of a spouse inherited IRA

Losing a spouse is one of the most difficult experiences that no one wants to go through. You've shared your life with this person, and when they die, you have to figure out how to move forward. One challenge many surviving spouses face is navigating their new financial situation, especially when the deceased spouse's accounts pass on to them. One of those accounts could be a spouse inherited individual retirement account (IRA).

If you are the beneficiary of your spouse's IRA, there are special rules regarding distributions and penalties you need to understand. Required minimum distribution (RMD) rules stipulate minimum amounts you must withdraw from an account each year. Failure to withdraw at least the required amount triggers penalties.It might seem overwhelming to learn all of these rules, especially during such an emotional time. But this breakdown of the options available to a spouse who inherits an IRA can help you understand what you need to know.

If you are a spouse who is the sole beneficiary of a traditional, rollover or simplified employee pension (SEP) IRA, you have several options. You may take a lump-sum distribution, establish an inherited IRA, transfer the assets into your own IRA or a combination of these.

You can transfer your deceased spouse's IRA into an inherited IRA. An inherited IRA is still in your spouse's name, and you cannot make any contributions to it. But it potentially can provide tax-deferred growth. It is important to know that if you choose this option, then you are subject to specific required RMD rules unique to spouse inherited IRAs.

This option is perhaps the simplest and can provide you with the most flexibility. As the spouse of the original account owner, you have the option of simply transferring the IRA into your own account. In this case, there are no additional rules or restrictions. It's as if the money had been yours, and the normal IRA rules apply.

A spousal beneficiary may withdraw the entire account balance as a single lump-sum distribution. While this grants you access to the money to use for whatever reason you choose—which can be extremely helpful to cover expenses after the death of a spouse—there are some significant drawbacks, including:

• The entire distribution is subject to income tax at your marginal tax rate. If the distribution is large enough, it may push you into a higher tax bracket.

• If you distribute the account, then you lose any remaining ability to benefit from the tax deferral the IRA provides.

If you take a lump sum, you can request the custodian of your IRA to transfer the money into your bank account, or you can transfer it into an investment account.

If you choose to establish an inherited IRA, the date that you begin taking distributions from the account depends on two factors: when your spouse passed away and how old they were at the time.

RMDs must start by December 31 of the year they would have turned RMD age or the year following their death, whichever is later.

If you inherit a Roth IRA from your spouse, then you have the same basic options available to you as outlined above for traditional IRAs. You can either:

• Transfer the money to your own Roth IRA. Since an inherited IRA transferred into your own account is treated as though the money was yours from the start. You own Roth IRAs are not subject to RMDs.

• Transfer it to an inherited Roth IRA. It's generally better to transfer an inherited IRA into your own account when the option is available because it is for spouses who are sole beneficiaries. However, if that option isn't available—perhaps because there are multiple beneficiaries—then you can open an inherited Roth IRA. The account will have to be distributed within 10-years of the account owner's death.

Some options outlined here are only available to spousal beneficiaries and only if they are the sole beneficiary. But if there are multiple beneficiaries—such as a child—on the original IRA account, then it needs to be split into separate inherited IRAs for each beneficiary; otherwise, you may lose the ability to use your own life expectancy if RMDs are required.

On top of the difficulty of losing a spouse, deciding on the best action to take with an inherited IRA can be stressful. Connecting with a financial advisor can help you better understand the rules and options for inheriting an IRA from your spouse. They can work with you as you embark on this next phase of life without your spouse and help you make the right decisions for your situation that set you up for a sound financial future.