^{Source: Henssler Financial}

If you and your spouse are both taking Required Minimum Distributions (RMDs) from your respective retirement accounts, it's crucial to understand the tax implications should one of you pass away. A surviving spouse has multiple options when inheriting an IRA, but choosing the right path can significantly impact future tax liabilities.

Key Considerations for Inheriting an IRA

A common question among retirees is: "If my spouse inherits my IRA, what’s the most tax-efficient option? Should they roll it over into their traditional IRA or establish an inherited IRA?" Since both of you are already taking RMDs, this decision can make a considerable difference in how much you pay in taxes over time.

At the end of 2024, the IRS provided clarity on rules regarding RMDs for inherited IRAs, specifically when the original account holder was already subject to RMDs before passing away.

Spousal Rollover: The Most Tax-Efficient Choice

In most cases, a spousal rollover is the most beneficial option. Certified Financial Planner (CFP) John Gjersten from BlueSky Wealth Advisors explains, "A spouse inheriting an IRA will almost always benefit from making a timely election to perform a spousal rollover." This allows the surviving spouse to continue using the Uniform Lifetime Table for RMD calculations, potentially lowering annual tax burdens.

The rollover option helps minimize immediate taxes by allowing the surviving spouse to defer distributions over their lifetime rather than being subject to the more aggressive 10-year withdrawal rule that applies to non-spousal beneficiaries. This results in smaller, more tax-efficient withdrawals over time, reducing the overall tax impact for both the surviving spouse and any future heirs.

How Does the 10-Year Rule Affect Taxes?

If a spousal rollover is not chosen, the IRA will be subject to the 10-year rule. This means the entire balance must be withdrawn within a decade, potentially pushing the beneficiary into a higher tax bracket. CFP Stephanie Campos from Campos Financial explains, "The 10-year rule forces larger withdrawals each year, leading to higher taxable income. This can also increase taxation on Social Security benefits and Medicare premiums."

Non-spousal beneficiaries, such as children, are typically required to deplete an inherited IRA within 10 years of the original owner’s passing. However, spouses have more flexibility.

Factors That Influence the Best Strategy

The right choice depends on multiple factors, including:

• The age difference between spouses: A younger surviving spouse may benefit more from a rollover, as they can spread out withdrawals over a longer period.
• The need for income: If the surviving spouse doesn’t need the extra income immediately, rolling the IRA over can help reduce taxable income.
• Charitable giving: If excess RMDs push the surviving spouse into a higher tax bracket, they might consider a Qualified Charitable Distribution (QCD), which allows up to $100,000 annually to be donated tax-free to an IRS-qualified charity.
• Estate planning goals: If the goal is to pass the IRA down to children, a rollover may be preferable since it delays larger distributions and minimizes immediate taxation.

What Financial Advisors Recommend

When deciding between a spousal rollover and keeping an inherited IRA, financial experts generally recommend consulting a fiduciary financial advisor who specializes in tax-efficient retirement strategies. Many advisors leverage tools like SmartAsset, NAPFA, and the CFP Board to provide tailored recommendations.

CFP Amy Hamasaki from Mountain Wealth Planning highlights, "Every situation is unique. If the deceased was already taking RMDs, it’s essential to determine whether the surviving spouse will continue based on their own age or switch to the new inherited account rules."

Final Thoughts: Choosing the Best Tax Strategy

For most retirees, rolling over an inherited IRA into the surviving spouse’s existing account is the best way to reduce tax liabilities and simplify financial planning. However, those who need access to funds sooner or want to maximize benefits for their heirs may need to explore alternative strategies.

Understanding IRS regulations, tax implications, and long-term financial goals is critical when making this decision. By taking the right steps today, surviving spouses can preserve wealth, minimize unnecessary taxes, and ensure a smooth transition of assets to future generations.

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