What to Do When You Inherit a Roth IRA From Your Spouse

When you inherit a Roth IRA, you need to pay attention to the rules to avoid penalties and taxes. Since money goes into a Roth IRA post-tax, rules governing withdrawals are somewhat less restrictive than the rules for traditional IRAs. However, you could still be liable for any interest earned on the account. Here are four options if your spouse passes away and leaves you a Roth IRA:

[Read: How to Pay Less Taxes on Retirement Account Withdrawals.]

Spousal transfer. With this rule, you can basically transfer the assets in your spouse's Roth IRA to an account in your name. You can transfer the funds to an existing Roth IRA or to a new Roth IRA that you set up. This only works if you're the sole beneficiary on the account, and your account will be regulated by the same distribution rules as if you had originally opened and funded the account.

You can access the funds contributed to the account at any time, but the investment earnings from the account will be taxable until you reach age 59 ½ or you've met the rules for the five-year holding period. So if you need to take money out of the account after you do a spousal transfer, check with your accountant about the potential tax liability.

Create an inherited IRA with the life expectancy method. This option still lets you transfer the assets in your spouse's IRA into an account held in your name, but this is a different type of account. When you open an inherited IRA, you will have to take required minimum distributions when your spouse would have attained age 70 ½ or by December 31st of the year following the year of your spouse's death, whichever is later.

The advantage of the life expectancy method is that it allows you to spread distributions over your own life expectancy without incurring a 10 percent early withdrawal penalty. Assets left in the account can continue to grow tax-free.

If other people, such as your children, are also account beneficiaries you should create separate accounts for each beneficiary by December 31 of the year following the year of your spouse's death. Otherwise, required minimum distributions will be established based on the life expectancy of the oldest beneficiary, which means the assets cannot remain in the account for as long a period of time.

[See: 10 Reasons to Save for Retirement in a Roth IRA.]

Create an inherited IRA with the 5-year method. This option is similar to the previous option. However, you must distribute the full value of the account within five years of opening your inherited IRA. You can spread the distributions out or take them all at once, and you won't incur the 10 percent early withdrawal penalty regardless of your age or the age of your spouse at the time of his or her death.

You can, with this method, continue to allow undistributed assets to grow tax-free for up to five years. The only rule is that the entire contents of the account must be distributed by December 31 of the fifth year after the year in which your spouse passed away. In other words, if your spouse passes away in January 2017, you have until December 31, 2021 to distribute the account's assets under this rule.

Take a lump sum distribution. With this option, the assets in the Roth IRA are distributed to you all at once. If the account is less than five years old when your spouse passes away, the earnings in the account will be taxable.

The lump sum distribution option can be helpful in some situations. But if your spouse's IRA contains a significant amount of money, the lump sum distribution could bump you into a higher tax bracket and increase your overall income tax bill for the year.

[See: 10 Ways to Avoid the IRA Early Withdrawal Penalty.]

Inheriting a Roth IRA from your spouse can be complicated, but most of these methods give you some time to think about your choices before locking yourself into one distribution plan. It could be helpful to talk to a financial advisor or accountant about your choices to figure out what will work best for your current financial situation.

Abby Hayes is a freelance blogger and journalist who writes for the personal finance blog The Dough Roller, which covers topics ranging from credit scores and banking to how much money you should be saving.