When you inherit an IRA from your spouse, you have options other beneficiaries don’t. While non-spousal beneficiaries must re-title the account as an inherited IRA to avoid penalties, as a spouse you can choose to treat the account as your own, roll it into your IRA, or re-title it as an inherited IRA.
What’s the difference between the alternatives?
Withdrawals from an account you treat as your own or re-title as an inherited IRA after your spouse’s death are exempt from the 10% early withdrawal penalty. [See Internal Revenue Code section 72(t)(2)(A)(ii).]
When you choose the option of rolling the account into your IRA, the assets become yours. That means if you start taking withdrawals after the rollover and you’re under age 59-1/2, you may have to pay a 10% early withdrawal penalty.
That’s what happened in T.C. Memo. 2010-146 (Sears). The taxpayer rolled assets from her deceased husband’s IRA into her own account and began taking withdrawals. She believed the withdrawals were not subject to the penalty because they were distributions to her as the beneficiary of her husband’s IRA.
The IRS said the rollover made the assets hers, and the withdrawals were premature and subject to the penalty because she was under age 59-1/2 at the time she took them.
The court agreed, to the tune of a $6,093.70 penalty.
Taxing Lesson: When it comes to IRAs, details matter.