Why You Want to Understand IRAs

In chapter 2 of Inheriting Your Spouse's IRA - The Widow's Guide to Keeping More of Her Assets, author Bill Harris explains the lessons from the court case about a surviving spouse beneficiary who learned “inherited IRA rules” the hard way.
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It may be tempting to let someone else “handle all the details.” I would encourage you to take an active role in understanding how inheriting your spouse’s IRA can impact your life.

William Harris

Bill Harris, RMA®, CFP®

As I shared earlier, there are trillions of dollars being sheltered in IRAs in the United States. And, IRAs have certainly had their days in tax court, you can be sure of that.

Take the often-cited court case of Charlotte Gee, a surviving spouse beneficiary who learned “inherited IRA rules” the hard way.

Charlotte’s Story

Charlotte inherited more than $2.5 million from her deceased husband’s IRA. At the time of her husband’s death, Gee was younger than 59½.

With guidance from very bad advice, Charlotte executed a spousal rollover for the full amount of the IRA. (A spousal rollover is when you take your deceased spouse’s IRA and you “roll it over” or make it your own.) The spousal rollover is perfectly legal.

At some point after the spousal rollover, Charlotte took a hefty distribution, or withdrawal, from her IRA, which now included the proceeds from her deceased spouse’s IRA. Gee reported the nearly $1 million distribution as taxable income, but she did not factor in a 10% penalty that typically accompanies withdrawals if you are below age 59½.

She assumed (or was improperly advised) that she was a beneficiary, and the 10% penalty would not apply. An exception does exist for spouses who inherit an IRA. The exception waives the 10% penalty if the spouse is under the age of 59½.

But when Charlotte made her husband’s IRA her own, she forfeited that exception. The IRS challenged her on this, and the issue went to the U.S. Tax Court. Charlotte Gee lost the case and was hit with a penalty of nearly $100,000. Also, she still owed income tax on the million-dollar distribution. Ouch!

Here are comments from the Tax Court:

“…once [Gee] chose to roll the funds over into her own IRA, she lost the ability to qualify for the exception from the 10-percent additional tax on early distributions. The funds became the petitioner’s and were no longer from her deceased husband’s IRA once petitioner rolled them over into her own IRA.”

This situation could have easily been avoided if Charlotte had known the rules and had she moved it to an inherited IRA. Any time money is in motion (such as withdrawals, transfers, or rollovers), there could be tax implications. Know the rules and understand how taxes can impact a transaction.

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.