Understanding the Differences Between a Spousal IRA and an Inherited IRA

Investing for retirement can be complex, and among the many financial tools available is the Individual Retirement Account (IRA). Among these, there are several unique types, like the spousal IRA and the inherited IRA (or inherited Roth IRA). Both share certain characteristics but also differ in important ways. Let's break down the key differences to help you understand how each works.

Spousal IRA: What It Is and How It Works

A spousal IRA is a type of IRA where one spouse can contribute to their spouse’s IRA. When one spouse is a non-working spouse, they can contribute to a spousal IRA, which helps to divide retirement contributions more equitably within a married couple.

Key Features of a Spousal IRA:

Contributions: Compatible with traditional or Roth IRA accounts. Contributions can be made by the working spouse to the non-working spouse's IRA. Mergeability: The IRA can be merged with other IRAs, such as the contributing spouse's own account, making it more flexible compared to other types of IRAs. No Distribution Requirements: Unlike traditional IRAs, there are no required minimum distributions (RMDs) during the life of the original owner or the surviving spouse, as long as the account remains a spousal IRA.

Inherited IRA (Including Inherited Roth IRA): What It Is and How It Works

An inherited IRA, or inherited Roth IRA, is a type of IRA that is taken over by a non-spouse beneficiary, usually a child or other family member, after the original owner's death. These IRAs are distinct from traditional or Roth IRAs that a person maintains during their lifetime.

Key Features of an Inherited IRA:

No Contributions: Once the original owner passes, no further contributions can be made to the IRA, as it becomes a beneficial asset of the beneficiary, not the original owner. No Merging Allowed: An inherited IRA cannot be merged with other IRAs or the inheritor's own IRA. This means the account is solely dedicated to the heir. Distribution Schedule: The inheritor must begin taking required minimum distributions (RMDs) by the end of the tax year in which the original owner would have turned 72 (or, if the owner died after turning 72, by April 1st of the following year). For Roth IRAs, the heir can manage the distributions as long as they adhere to the 5-year rule if the account is less than 5 years old at the owner's death.

Comparing Spousal IRA and Inherited IRA

The primary differences between a spousal IRA and an inherited IRA lie in how they are funded and managed, and the flexibility they offer in terms of contributions, distributions, and the type of IRA they are.

Key Differences:

Contributors: A spousal IRA is funded by a spouse contributing to their partner, while an inherited IRA is funded by the original owner and taken over by a non-spouse beneficiary. Flexibility: Spousal IRAs can be merged and continue to accept contributions from the contributing spouse. In contrast, inherited IRAs cannot be merged and do not accept further contributions. Distribution Rules: Spousal IRAs do not require RMDs during the original owner's lifetime or the surviving spouse's lifetime, while inherited IRAs require RMDs by a specific deadline following the original owner's death.

Example Scenarios

Let's consider two scenarios to illustrate the differences:

Scenario 1: Spousal IRA

A working spouse contributes to their non-working spouse's Roth IRA. The account remains a personalized and separate investment tool for the non-working spouse, with no RMD requirements. If the working spouse dies, the non-working spouse can continue to contribute and manage the account as their own Roth IRA.

Scenario 2: Inherited IRA

After the original owner dies, a child takes over the inherited IRA. No further contributions can be made to the account. The child is required to begin withdrawing RMDs within a set timeframe, contingent on the original owner's date of death.

Conclusion

Both spousal IRAs and inherited IRAs serve as crucial components of retirement planning, but they function quite differently based on the nature of their funding and management. Understanding these nuances is vital for making informed decisions about your retirement savings and ensuring your financial legacy is cared for properly.

In summary, spousal IRAs allow for continued contributions and flexibility in management, while inherited IRAs are more rigid in terms of restrictions and distribution requirements. Whether you're planning for your own retirement or setting up accounts for potential heirs, it's essential to grasp these key differences to maximize the benefits of these financial tools.