Choices for the spouse of a deceased IRA owner.

For many people, a large individual retirement account (IRA) is, or will be, a significant asset in their estate. Typically, the spouse is the sole beneficiary of a decedent's IRA account. There are a number of tax saving opportunities for such spouses.

Generally, an IRA owner must begin taking minimum distributions from the account no later than April 1 of the year following the year in which he reaches age 70 1/2. Even though the required beginning date for distributions may have passed for the original IRA owner, a surviving spouse still has important choices about the disposition of the account. A review of these rules may save the surviving spouse significant future tax dollars.

If the surviving spouse takes no action, distributions to him will be determined by the distribution method chosen prior to the accoUnt owner's death. Most IRA holders choose the annual recalculation method for determining minimum distributions; this allows the IRA owner and spouse to use their attained ages as of their birthdays each year when looking up their joint life expectancy in the IRS tables (in Publication 590).

The result is that their joint life expectancy is reduced by less than one in each succeeding year. If this method has been chosen, the surviving spouse may continue to receive minimum distributions calculated under the surviving spouse's single life expectancy determined by the IRS tables. At the death of the second spouse, the balance of the IRA account must be paid to his estate no later than December 30 of the year following the year of the surviving spouse's death. This means that, in addition to any estate tax consequences, the entire remaining IRA balance is subject to income tax in the year it is distributed. (Because the 15% excise tax has been repealed effective for distributions after 1996, no excise tax would apply to the remaining account balance.)

The IRA owner may have chosen the term-certain method for determining the required annual minimal distribution. The term-certain method requires that the joint life expectancy be determined for the year the IRA owner reaches age 70 1/2. The IRA balance at the beginning of each distribution year is divided by the joint life expectancy reduced by one for each distribution year.

Under this method, distributions to the surviving spouse could continue based on the original life expectancy factor, less one for each distribution year. This has the effect of reducing the required annual distributions after the death of the first spouse, because the distribution schedule does not change. On the surviving spouse's death, IRA payments continue under the term-certain method until the term expires. Because the balance of the IRA is not required to be distributed (as in the recalculation method), no bunching of income needs to occur.

Usually, a better alternative is for the surviving spouse to roll over the balance of the decedent's IRA account into a new IRA account. This provides the spouse with added flexibility. The surviving spouse should name a designated beneficiary of the spousal IRA rollover as soon as possible, to reduce the required minimum distribution from the new IRA.

Even if a surviving spouse is older than age 70 1/2 at the inception of the spousal rollover account, a new distribution method and beneficiary may be chosen. However, without a beneficiary, the surviving spouse must calculate the minimum required distribution from the rollover IRA based on one life only. In addition, if the recalculation method is used without a beneficiary, the account will be distributed no later than the year following the death of the surviving spouse.

If the surviving spouse rolls over the IRA account and names a child as beneficiary, the required distribution can be calculated based on the joint lives of the survivor and a person 10 years younger. This increases the time in which the account can build tax-free. In addition, the surviving spouse must decide between electing the term-certain method or the annual-recalculation method for determining minimum distributions from the account.

The surviving spouse may wish to split the rollover account into several new IRAs to add flexibility in naming beneficiaries with varying investment objectives. Letter Ruling 9630034 suggests that trustee-to-trustee transfers may be used to avoid the rule of one rollover per year.

On the death of the second spouse, required distributions to the child beneficiary would be based on the child's life expectancy determined when the parent reaches age 70 1/2, and reduced by one for each year in which required distributions were made to the parent. The number of years used in the computation would vary, depending on whether the parent used the term-certain method or the annual-recalculation method. In either case, the result would extend the required distributions over a period of years based on the life expectancy of the child, rather than that of the parent.

Several choices are available for a surviving spouse beneficiary that can have a significant effect on the timing of IRA distributions. Planning soon after the decedent's death is important to achieve the most favorable result for the surviving spouse and the beneficiary of his IRA.

From Cecil McPherron, CPA, MT, and Lorna Doversberger, CPA, MT, Anderson & Whitney, P.C., Greeley, Colo.