IRA Advice for Same-Sex Couples

One of the most dangerous--and costly--financial mistakes you can make is to assume that the rules which govern one type of retirement account apply to others.

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For instance, by April 1 of the year after you turn 70½ you must begin to withdraw a minimum amount of money from a traditional IRA. You are subject to a 50% penalty if you don’t. On the other hand, while the same deadline and penalty apply, the so-called ‘Required Minimum Distributions” (RMDs) may or may not be required from your 401(k) account.(1)

Thanks to the 1974 law known as ERISA, the Department of Labor oversees most of the retirement and health benefit plans employers sponsor. These include the 401(k), 403(b), 457, health and vision insurance plans, etc. However, the DOL has limited jurisdiction over Individual Retirement Accounts, more commonly known as IRAs.

That’s why individuals in same-sex marriages need to clearly understand the rules that govern the various accounts each partner has. As I wrote last week, DOL announced that same-sex couples who were legally married in a jurisdiction that sanctions such unions, will have the same privileges and obligations as heterosexual spouses when it comes to plans that DOL regulates.

This includes the requirement that your spouse be the primary beneficiary of your 401(k) unless s/he waives this right in writing. However, Barry Picker, certified public account at Picker and Auerbach, points out that this rule does not necessarily apply to IRAs because each state- not the DOL- governs this aspect of the accounts. “It’s a state rule, not a federal one,” says Picker.

In fact, while some states require that your spouse inherit your IRA when you die, others have no rule about this at all, allowing you to name anyone you wish as your primary beneficiary.

Here’s where you can run into trouble. Let’s say that after your divorce you named your son as the primary beneficiary of your IRA. A few years later, you remarry and don't change your beneficiary to your current partner assuming this account must, by law, go to your new spouse. But the DOL rule does not apply to IRAs.

“A same-sex spouse does not automatically inherit an IRA," says Picker. "If the state you live in does not recognize same-sex marriage, your son gets the IRA” if you die.

In fact, given the same set of circumstances, the same outcome would apply if you are in heterosexual marriage: If your state doesn’t require that your spouse inherit your IRA, your son- not your current spouse- would get the money.

According to Picker, in light of the recent DOL advisory, there’s a new tax planning option for individuals who were in a same-sex marriage and who inherited their late partner’s IRA or company-sponsored retirement plan. They are now considered the legally-recognized spouse and have the right to roll over those assets into an account (typically an IRA) in their own name. If the surviving spouse is under age 70½, annual RMDs can stop, allowing the assets in the account to continue to grow on either a tax-free or tax-deferred basis.(2)

Picker maintains this is allowed even if the spouse has already been taking Required Minimum Distributions for years. He says that several cases have set the precedent that “there is no time limit on a spousal rollover, even if the spouse had started RMDs.”

As a CPA, he also strongly recommends that same-sex couples seek advice as to whether it would be in their favor to re-file their income tax returns for the past three years as “married, filing joint.” In fact, regardless where you live, for federal income tax purposes, legally married gay couples must file as “married” starting with their 2013 return.

1. For instance, regardless of your age, you do not have to take an RMD from your 401(k) if you are still working at the employer sponsoring the account (and do not own 5% or more of the company).

2. Assets grow tax-free only in Roth accounts.