But you might run into tax trouble if you’re middle age or younger and you need some cash right away.
Strategy: Take a partial payout first. Then, roll over the remainder to your IRA, or name your spouse’s IRA as your own. With that two-step approach, you avoid the usual 10 percent tax penalty for early withdrawals (before age 591/2).
A taxpayer in a new Tax Court case (Gee, 127 TC No. 1) did just the opposite. She immediately rolled over the funds to her own IRA and later withdrew some funds. Much to her dismay, she was penalized, even though she seemed to qualify for an exception.
Here’s the drill: If an IRA participant takes a distribution before age 591/2, he or she generally must pay a 10 percent penalty. But the tax law is littered with exceptions to that general rule. For instance, the IRS imposes no penalty for IRA distributions made on account of death or disability.
That was the taxpayer’s point in her case. But the Tax Court said her rollover prior to the distribution changed the transaction’s nature.
Facts of the case: Four years after rolling over her late husband’s IRA funds into her account, the taxpayer withdrew almost $1 million. She argued that her withdrawal was exempt from the 10 percent penalty tax because it equaled a distribution made to a beneficiary upon a decedent’s death.
But the Tax Court disagreed, ruling that the taxpayer no longer qualified for the death-benefit exception once she transferred the funds to her own IRA. Thus, she’s liable for the penalty.
We’re not talking chump change here. The 10 percent penalty for a $1 million distribution is $100,000. If you add that to the regular income tax due on a $1 million distribution, a taxpayer in the 35 percent tax bracket may have to fork over as much as $450,000 of the payout to Uncle Sam.
If you’re in a similar position, don’t rush into any decisions. You can elect to treat an IRA as your own any time after the calendar year of a deceased spouse’s death. (IRS regulation 1.408-8) No 60-day rollover requirement applies.
Tip: In lieu of taking a cash distribution first, you can postpone withdrawals until you reach age 59 1/2. Of course, that assumes you don’t have a current cash crunch.