Life can be difficult and complicated for surviving spouses. Contending with some financial rules and procedures in addition to everything else can amount to piling on. Yet, widows and widowers need to make key decisions about their finances, and some decisions need to be made within deadlines. Social Security, IRAs, employer retirement plans, and investments are the major areas with deadlines or some urgency. This month I identify the key Estate Planning issues that arise in the first year and present some tips for dealing with them.
The best advice for a surviving spouse is not to make financial decisions in a hurry.
There’s enough time to seek advice and collect information, review the options, and make the best estate planning decision. As with other financial and estate planning issues, you shouldn’t rely on a rule of thumb or copy what someone else did. Your estate planning situation could be different or things might have changed, making a different action the better one.
You are eligible for the higher of your own Social Security retirement benefit or a survivor’s benefit. A survivor’s benefit can be paid as early as age 60. The survivor’s benefit generally is 100% of the retirement benefit the deceased spouse was receiving or would receive at normal retirement age.
But the survivor’s benefit has the same timing rule as retirement benefits. When you take the benefit before normal retirement age the amount you receive is reduced. So a surviving spouse who wasn’t already receiving Social Security retirement benefits or wasn’t estate planning to begin them soon shouldn’t automatically claim survivor’s benefits even if he or she is age 60 or older. You want to think long term. Delaying benefits can increase them substantially, so you might not want to begin benefits just because you’re eligible. When you don’t need the income right away, you could be better off long term by waiting and letting the benefits increase.
For more details about the Social Security benefits for survivors, check out the Social Security web site. You can obtain their booklet, What Every Woman Should Know. You also should look at the pages ssa.gov/retire2/agereduction.htm and ssa.gov/survivorchartred.htm.
Individual Retirement Accounts.
Surviving spouses have three choices when they’re the sole beneficiaries of a spouse’s IRA. You can withdraw all the money and pay income taxes on it. You also can choose from two rollover or transfer options.
Surviving spouses have a special option to rollover the inherited IRA to an IRA in the survivor’s name. This will be treated as a new IRA and sometimes is called a ?fresh start IRA.? The surviving spouse won’t have to begin required minimum distributions until he or she is over age 70½ and then will take them based on his or her own life expectancy. A new group of beneficiaries also can be selected.
The other option is to transfer the IRA into an inherited IRA the way other beneficiaries have to. The beneficiary of an inherited IRA must begin required minimum distributions by Dec. 31 of the year after the year of the owner’s passing. When the deceased owner already reached age 70½, the beneficiary can continue the distribution schedule he or she was using or can schedule the distributions over his or her own life expectancy. When the owner wasn’t already age 70½, the distributions can be taken over the beneficiary’s life expectancy or the IRA can be emptied by the end of the fifth year following the year of the owner’s passing.
In most cases the best move for surviving spouses is to roll over the inherited IRA to a new IRA. That creates more options and flexibility. But there’s a catch when the survivor is under age 59½. If distributions are taken from a rolled over IRA before age 59½ the distributions are subject to both income taxes and the 10% early distribution penalty. But when the distributions are from an inherited IRA that wasn’t rolled over to a new IRA, the distributions aren’t subject to the 10% penalty. A younger survivor who plans to take distributions from the IRA is better off with the transfer to an inherited IRA instead of a rollover to a new IRA.
Another consideration is the beginning date for distributions from the IRA when there is flexibility. The usual advice is to leave money in an IRA as long as possible to take advantage of tax deferral. But that’s not always the best advice. When the survivor is in a low tax bracket suddenly and expects that to continue for a few years before returning to a higher bracket, it could be a good idea to take distributions from the IRA in the near term instead of in the future when it might be taxed at higher rates.
Filing estate tax returns.
A 2010 law created portability of lifetime estate tax exemptions for estates of those who pass away in 2011 and 2012. Each person has a $5 million lifetime exemption. When one spouse passes away and the estate isn’t valuable enough to exhaust the $5 million exemption, the unused amount can be transferred to the surviving spouse. That gives the surviving spouse an exemption of $5 million plus whatever wasn’t amount used by the other spouse.
The trick is that under IRS regulations the surviving spouse can’t use that surplus exemption unless the estate of the first spouse filed an estate tax return and elects to transfer the surplus to the surviving spouse. The IRS says it assumes the election to transfer is made if a return is filed and it doesn’t say it is not making the election.
This means for portability to be effective, the estate of the first spouse to pass away must file an estate tax return, even if it otherwise isn’t required to under the law. A surviving spouse and the executor must be aware of this rule and file a return to preserve the unused exemption. It can cost some money in professional fees to file an estate tax return, so consider whether the unused exempt amount really might be needed. If the assets are likely to grow in value over time to exceed the current $5 million limit, it’s probably a good idea to file a return.
Survivors and executors also need to keep state level taxes in mind. Many states impose estate or inheritance taxes at lower levels than the federal government. A return for the state might be required even one a federal return isn’t. Also, there might be elections and options that could reduce the state tax.
Often a surviving spouse doesn’t really know what the other spouse’s portfolio strategy was. Or the two spouses have very different risk tolerances or investment ideas. Ideally, the deceased spouse either explained the details to the other spouse or was using a professional estate planning advisor or money manager who can provide continuity in portfolio management. But that often doesn’t happen.
A surviving spouse shouldn’t make big moves with an inheritance right away, but the survivor does need to take ownership of the portfolio and adapt it to the new circumstances over time. Too often, the surviving spouse believes little or nothing should be changed in the portfolio. Sometimes the deceased spouse told the other spouse not to change the strategy or portfolio. Or the deceased spouse had said certain investments never should be sold. At other times the survivor either believes the portfolio shouldn’t be changed or isn’t sure of the changes to be made.
A survivor needs to be sure the portfolio over time is adjusted to reflect his or her income needs, risk tolerance, and other circumstances. Professional help should be sought when the survivor needs guidance and the deceased spouse didn’t leave advice regarding professional money manager.
RW January 2012.