Changes for Inherited IRAs?

Relationships and finances confuse you enough already. Then your spouse dies. During a hurricane of emotions you must make tough decisions about such money matters as individual retirement accounts – amid ever-changing rules about money available to you from a spouse’s IRA. By this summer, the rules might change completely.

Only a surviving spouse can roll a deceased spouse’s IRA and retirement plans into one account. The other choice: an inherited IRA where the beneficiary must begin to take required minimum distributions (RMDs) regardless of age.

Spouse beneficiary options in retirement plans apply only if you are the sole primary beneficiary of the IRA. If the account owner dies, you the spouse can: Begin distributions no later than Dec. 31 of the year after the year when the IRA’s owner died (calculate distributions using the longer of the deceased’s remaining life expectancy or yours); or you can treat the IRA as your own and begin RMDs when you reach your required beginning date to start such withdrawals, typically 70½.

Much discussion rages about when two taxpayers marry and see their joint taxes increase beyond what they paid before filing a joint return. Discussion is more limited over what’s often called the “widow’s penalty” regarding retirement accounts.

As a surviving spouse, you typically retain all assets in defined contribution retirement plans such as 401(k)s and 403(b)s for school and tax-exempt organization employees, as well as in IRAs. When RMDs kick in, you no longer withdraw at the marginal rates available at the tax filing status of Married Filing Jointly but rather as an individual filing single. You get a break for two years if you have a dependent child at home.

The tax rates can effectively increase your marginal tax rate to higher levels with no additional income – the widow’s penalty.

Recent developments further complicate the issue as courts ponder creditor protection for inherited accounts. Although the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 indisputably protects retirement funds, a real question lingers about inherited retirement funds retaining a retirement character. Three U.S. appeals courts ruled on the issue, two of the courts favoring protection of inherited IRAs in bankruptcy.

The U.S. Supreme Court agreed to listen to the case most recently decided, rendering the 2-1 advantage meaningless. (The case, Clark v. Rameker, involves whether creditors can dun a Wisconsin couple, owners of a tanked pizza shop, who declared bankruptcy and who then inherited a $300,000 IRA.)

Our colleague Seymour “Sy” Goldberg filed an amicus curiae (“friend of the court”) brief arguing against considering non-spouse inherited IRAs as retirement funds. His reasoning:

1. Contributions may not be made to an inherited IRA, whereas they can be to an individual’s own retirement account.

2. Distributions to beneficiaries must generally begin in the year following the year of the IRA owner’s death regardless of the beneficiary’s age; distributions of an IRA owner’s own account are not required until age 70½.

Oral arguments in the Supreme Court case took place March 24, with a final decision expected in June. Stay tuned.

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Joseph “Big Joe” Clark, CFP, is the managing partner of the Financial Enhancement Group LLC, an SEC Registered Investment Advisory firm in Indiana. He teaches financial planning at Purdue University and is the host of Consider This with Big Joe Clark, found on WQME and iTunes. He is a Registered Principal offering Securities and Registered Investment Advisory Services through World Equity Group, Inc, member FINRA/SIPC. Big Joe can be reached at bigjoe@yourlifeafterwork.com, or (765) 640-1524. Follow him on Twitter at @Big Joe Clark and on Facebook at http://www.facebook.com/FinancialEnhancementGroup.

Securities offered through and by World Equity Group Inc. Member FINRA/SIPC. Advisory services can be offered by the Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.

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