Relationships and finances can often be complex. However, things can get even more complicated when a spouse passes away.
As a spouse — and only a spouse — an individual can roll their deceased spouse’s IRA and retirement plans into their own name. The other choice is to take an inherited IRA where the beneficiary must begin to take required minimum distributions (RMDs) regardless of their age.
While much ink has been invested in the “marriage penalty” that can result when two taxpayers marry — and subsequently watch their joint tax liability increase above where they were prior to filing a joint tax return — there has been limited conversation devoted to what’s often called the “widow’s penalty.”
As a surviving spouse you typically retain all the assets in defined contribution retirement plans (401ks and 403bs) as well as IRAs. When RMDs are required, you will no longer withdraw at the marginal rates of "Married Filing Jointly" but rather as a single individually. You can 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 without any additional income, hence we call it the “widow’s penalty.”
Recent information has further compounded the issue as the courts are pondering creditor protection for inherited accounts. Although the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act indisputably protects “retirement” funds, there’s a real question as to whether or not inherited retirement funds retain their retirement character. To date, three separate U.S. Courts of Appeals have ruled on the issue, with the score, so far, 2-1 in favor of protecting inherited IRAs in bankruptcy. As with all issues tax related, things change!
The Supreme Court has agreed to listen to the most recently decided case, Clark v. Rameker. As a result, the 2-1 advantage is meaningless. Our colleague, Sy Goldberg, has filed a Brief of Amicus Curiae, which translates to “friend of the Court.” In essence, it’s a legal brief that says, “Here’s how I think you should rule and why.”