IRC Section 402(c)(9) allows a rollover the deceased spouse’s IRA to a surviving spouses IRA. Further, the Treasury Regulations state that the surviving spouse thereafter treats the IRA as his/her own. Keep in mind that there can be both pros and cons to this treatment. For example, if the surviving spouse is significantly younger (e.g. under 59 ½ years old) than the deceased spouse and the surviving spouse might need to take distributions soon, rolling the IRA into the surviving spouses name might not be a good idea. On the other hand, if the surviving spouse is much older, rollover the funds over could accelerate “required minimum distributions”.
With regards to creditor issues, the protections depend on the type of IRA – for example, a SEP IRA is technically covered by ERISA, which generally grants higher creditor protection (for both original account owner and inherited owner). For other types of IRAs, the creditor protection can depend on the type of debt involved (e.g. bankruptcy vs. non-bankruptcy). For example, the original accountholder of an IRA can generally have up to $1M protected from bankruptcy creditors and if, in your situation, the surviving spouse had rolled the funds over and treated the account as her own going forward, she would be entitled to this protection (note that the trend with bankruptcy courts across the country is to favor bankruptcy creditors when the IRA is treated as an inherited IRA – i.e. a non-spouse inherits the IRA). Also, watch out if the IRA has been involved in any “nontraditional” investments (e.g. real estate, privately-held companies, etc.). Courts are starting to realize that these investments have the potential to raise “prohibited transaction” problems – which, if found, can result in the retroactive invalidation of the IRA – meaning that the general creditor protections of the IRA are eliminated – not to mention horrific income tax / penalties if the IRS finds out about the prohibited transaction.
The creditor protection issue for IRAs is non-bankruptcy situations can be much murkier, depending on where the beneficiary of the IRA (i.e. the person who inherited the IRA) lives.
Of course, an IRA owner that is concerned about his/her beneficiaries’ creditors can leave the IRA to an “IRA Legacy Trust” (either a stand alone trust or within the IRA owner’s Will) – which can not only provide additional creditor protection, but also control the beneficiary’s ability to potentially accelerate IRA distributions in a tax-foolish manner.
If you have any questions about spousal rollovers or conversion, please do not hesitate to call our office.