If you are entitled to inherit an IRA from your spouse, avoiding spousal beneficiary mistakes is a high priority. Let’s cover some basic ones.
Defining a Spouse Beneficiary
While this may seem obvious to most, a spouse beneficiary must be married to the account owner at the time of the account owner’s death and must be named on the beneficiary form (or inherit directly through the custodian’s document default provisions).
Here is a compelling cautionary tale. It is an actual court case: IBEW Pacific Coast Pension Fund v Lee (2012, CA6), February 13, 2012.
Wayne Lee died with two wives and one pension plan. Wayne never got a legal divorce from his first wife. Wayne Lee was a member of the International Brotherhood of Electrical Workers (IBEW) and contributed to their pension fund (an ERISA plan under the Employee Retirement Income Security Act). Wayne married Cleta in the State of Washington in February 1979.
In the early 90s, Wayne moved to Mississippi without Cleta to find a job. He found a job, as well as a new wife, Lois, who he married in 1995. Wayne retired in 1997 and applied for his benefits from the pension fund. He identified himself as married and named his new wife, Lois, as his spouse. On the beneficiary form, Wayne listed Lois as the beneficiary of “any benefits which may be payable from the IBEW Pacific Coast Pension Fund as the result of [his] death.”
Wayne died in 2007, and Lois began receiving her monthly benefits. Soon after, Cleta (the first wife) appeared and applied for survivor benefits from the same pension fund.
She attached her 1979 marriage certificate and stated that she and Wayne had never divorced. As you would anticipate, the case went to court. First wife Cleta eventually won the case.
The lesson to learn is that ERISA law trumps beneficiary forms.
Again, while this should be obvious, a spouse beneficiary must be “legally” married to the account owner at the time of the account owner’s death and must be named on the beneficiary form.
Splitting an IRA
Can IRAs be split? In practice, we often see people naming more than one beneficiary. For example, it may be a couple’s second marriage, and the wish to leave a legacy to the current spouse and kids from a previous marriage is very common.
If this is the case, a spouse can still take advantage of these special provisions by transferring or splitting her portion of the inherited IRA to a separate account by December 31 of the year following the year of the IRA owner’s death.
If a spouse beneficiary needs money from the IRA before age 59½, she will likely want to remain a beneficiary of the inherited IRA account.
Death offers an exception to IRA’s 10% early-distribution penalty, so by remaining a beneficiary, she can avoid paying the 10% early withdrawal penalty. However, the account needs to be retitled properly as an inherited IRA.
Converting With a Spousal Rollover
Once a younger spouse beneficiary reaches age 59½, there is no longer any advantage to remaining a beneficiary of an inherited IRA. The spousal rollover or transfer should be completed once the age of 59½ is reached. No deadline exists for this transaction—and no other beneficiary has this option.
As mentioned several times previously, a surviving spouse should name her own beneficiaries. If no beneficiaries have been named and the surviving spouse dies, the remaining assets will pass according to the default provisions in the custodial document. The default may be the estate. This result will add unnecessary time and expenses by tying up the assets in probate, requiring a quicker mandatory payout, and possibly causing the wrong beneficiaries to inherit the IRA.
Never make any contributions to your inherited IRA. Only an account owner can make annual contributions to an IRA. While a spouse beneficiary with earned income can technically make contributions to an inherited IRA, it should be avoided. If, as a spouse beneficiary, you do contribute, it causes the IRA to be deemed your own, and it loses its inherited IRA status and the benefits which ensue.
The above article originally appeared as a chapter in Inheriting Your Spouse's IRA and is reprinted with permission from the author Bill Harris, RMA®, CFP®. No parts of this article may be reproduced without correct attribution to the author of this book.
You can find the full book here.