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Widows and Money

So You Inherited an IRA. Now what?

By Financial Planning, Retirement, Widows and Money

Wealth Management: Putting Your Interests First

Or a 401(k), or a SIMPLE IRA or a SEP IRA….

It depends first on your relationship to the account’s original owner – were they your husband or wife? The IRS has one set of rules for spouses who inherit retirement accounts and another set for everyone else.

Next, it matters how contributions were made into the account. Were pre-tax dollars used, as with a traditional IRA, 401(k), SEP or SIMPLE IRA? Or were after-tax funds used, as with a Roth IRA or Roth 401(k)?

Lastly, to the extent you have options, ask yourself whether you need the funds you’ve inherited, and, if so, when.

OPTIONS WHEN YOU’VE INHERITED AN IRA FROM YOUR LATE SPOUSE

DO YOU NEED THE MONEY NOW?

If so, you can take a lump sum distribution and there will be no penalties if you are under 59.5 years old. In the case of a Traditional IRA, the entire distribution will be considered taxable income to you. For a Roth IRA, because taxes were paid on the dollars originally contributed, only the portion of the distribution that represents earnings (or growth, inside the account) will be taxable income. Depending on the size of the inherited account and your other income, taking a lump sum distribution could result in a large tax bill that year, so be cautious and consult your tax professional before doing anything.

An alternative for those needing to access the inherited funds in the near term is to make withdrawls over five years. To do this, you set up an Inherited IRA in your name and transfer the funds from your late spouse’s IRA into the new Inherited IRA and tell the IRS that you have elected to take distributions using the five-year method. You can choose how much to withdraw each year, but must exhaust the account by December 31st of the fifth year after the year of your spouse’s passing. This can be done with both Traditional and Roth IRAs and there will be no penalties on distributions if you are under 59.5 years old. One caveat is that you will not be able to make any contributions to that Inherited IRA over those five years.

DON’T NEED THE MONEY NOW?

 You have two choices – transfer the funds into an account you own (a “spousal transfer“) or into an Inherited IRA in your name. The rules regarding future contributions and required minimum distributions differ significantly, so let’s compare and contrast the two options.

SPOUSAL TRANSFERS

First, know that spousal transfers are an option for surviving spouses only when they are the sole beneficiary of their late spouse’s account.

Now, after inheriting a Traditional IRA you can treat the funds as if they were your own and roll them into your own IRA account in a spousal transfer. You can make contributions to the account in future years if you have earned income. The funds are available for distribution anytime, but will be subject to a 10% penalty if you are under 59.5 years old and do not meet any of the IRS’s hardship exemptions. If your late spouse was already taking their required minimum distributions (RMDs), you must take the RMD for the year of their death. Going forward, no further RMDs will be required until you yourself reach 72 years old and those RMDs will be based on your age, not your late spouse’s.

After inheriting a Roth IRA you can also do a spousal transfer into your own Roth IRA. You can withdraw dollars that represent contributions anytime, penalty and tax free. You can withdraw dollars that represent earnings – or growth inside the account – penalty and tax free if you are at least 59.5 years old and five years have passed since your spouse’s Roth account was opened. Because the dollars used to fund a Roth IRA have already been taxed, there are no requirements for RMDs in Roth IRAs, even when they’ve been inherited.

INHERITED IRA ACCOUNTS

If you are not the sole beneficiary of your late spouse’s IRA, you may open an Inherited IRA in your name and roll the funds from your late spouse’s account into your Inherited IRA. Going forward, you can take distributions but cannot make contributions (ever).

If the IRA you inherited is a Traditional IRA, you can take distributions anytime and penalty-free if you’re younger than 59.5 years old. If your late spouse was taking required minimum distributions (RMDs), you must take his/her RMD in the year of their death. Thereafter, RMDs will kick in when you are 72 years old and be based on your age, not your late spouse’s.

If you’ve inherited a Roth IRA, you can withdraw dollars that represent contributions anytime penalty and tax-free. You can withdraw earnings – or growth inside the account – penalty-free regardless of your age. Withdrawls of earnings will also be tax-free so long as the account has been open for at least five years. The IRS does require minimum distributions or RMDs starting the later of (1) December 31st of the year following the year of your spouse’s death; or, (2) the date your late spouse would have turned 72.

WHAT IF I INHERITED AN IRA FROM A PARENT, SIBLING OR FRIEND?

It used to be a little complicated, but thanks to passage of the SECURE Act into law in December 2019, it’s now quite simple. Now, when you inherit an IRA or other retirement account – whether Traditional or Roth – you must take distributions of all funds in that account by December 31st of the tenth year following the death of the original account owner.[1]Distributions from Traditional IRAs will be taxable income to you and thus can create a sizable tax bill, depending on your other sources of income. Thankfully, the IRS gives you the freedom to decide how much to withdraw in each of those ten years, so you can work with your tax professional to come up with a strategy to minimize the taxes you’ll have to pay.

[1]There are some exceptions, namely, if the non-spouse beneficiary is a minor child, disabled or chronically ill or is less than ten years younger than the original account owner.

Social Security Provides Benefits for Older Widows Too

By Cash Flow Planning, Financial Planning, Social Security, Widows and Money

Widows 60 or older (50 if disabled) are entitled to receive survivors’ benefits from Social Security based on their late husband’s work record. This includes divorced women whose ex-husbands have died if they were married to the deceased for 10+ years and did not remarry before the age of 60.

These widows receive 71.5% – 100% of what their late husband would have collected at his full retirement age (“FRA”), which is 66 plus some number of months for those born 1945-1959, and 67 for those born in 1960 and later. The exact percentage of their late husband’s benefit that they will receive as widows depends on the widow’s age and how close she is to her own full retirement age. If she has reached her own FRA, she’ll receive 100% of what her late husband would have received at his FRA. The further away she is from her own FRA, the lower the percentage.

What could this mean, in dollar terms?

Currently, the average Social Security benefit is $1,461 per month, while the maximum benefit for someone who’s reached his FRA is $2,861. Thus a widow could receive something in the range of $1,045 to $2,861 per month in survivors’ benefits. This can provide valuable support while a widow is in transition.

That said, there are a couple of things to think about.

First, for women who work and who have not reached their own FRA(1), these widow’s benefits will be taxed at $1 for every $2 of income they earns above $17,640 (2019). For those who have reached their FRA, their widow’s benefits will not be reduced by any income earned from work.

Second, collecting survivors’ benefits will not impact the retirement benefits a woman can claim on her own work record or that of her late husband.

Third, once she is 62 and can collect her own retirement benefit, a woman cannot collect both a survivor’s benefit and a retirement benefit. Social Security will pay only one benefit, and will pay whichever is the higher of the two.

It’s important for widows to file for survivors’ benefits as soon as possible. The Social Security Administration will pay claims retroactively to the date of the filing, but not the date of death.

(1)66 plus some number of months for those born 1995-1959, and 67 for those born in 1960 and later

Social Security “Survivors Benefits” for Widows and Children

By Cash Flow Planning, Financial Planning, Social Security, Widows and Money

Did you know that Social Security provides “survivor benefits” to widows and their children?

Widows can receive benefits, for themselves, if they are caring for a child under 16 or a child of any age who is permanently disabled. Each child under 18(1) can also receive a monthly check for him/herself, payable to the parent. The benefits paid to the widow and her child will each be equal to 75% of what the deceased father would have received at 67, his full retirement age (“FRA”).(2)

So, what could this look like, in dollar terms?

Currently, the average Social Security benefit is $1,461 per month, while the maximum benefit for someone who’s reached his FRA is $2,861. Thus a widow and her child could together receive something in the range of $2,100 to $4,300 per month in survivors’ benefits.

There are some limitations, however.

For widows who work outside of the home, their own widow’s benefit will be reduced by $1 for every $2 earned above $17,640 annually (2019). Since most women earn well above this threshold, the value of the widow’s own benefit is quickly lost.

That said, no matter a widow’s income, filing for the children’s benefit is a no-brainer. It’s found money. These benefits will continue for each child until s/he reaches 18(1) and will rarely be taxed.(3)

There is a maximum benefit that a family can receive, meaning that your combined benefit, widow’s plus children, is capped at 150-180% of the benefit the deceased father would have received at his FRA.

It’s important for widows to know that collecting survivors benefits now will not impact the amount you will ultimately collect in retirement benefits down the road – whether you plan to collect those retirement benefits on your deceased spouse’s earnings record or your own.

Widows must file for benefits in person at their local Social Security Administration office and should do so soon after their husband’s death. Once the application is processed, the Social Security Administration will pay benefits retroactive to the date the application was filed, not to the date of their husband’s death.

Social Security survivors benefits will not likely replace 100% of a late husband’s income, but they can provide valuable support in a widows transition.

(1)Or up 19 years, 2 months if still in high school full time

(2)67 for those born in 1960 or later

(3)The children’s benefits are only taxed if the children themselves have significant income – about $25k – from other sources