If your spouse dies before April 1 of the year after he or she turned 70 1/2 (which is when minimum withdrawals must begin) or at any earlier time, you generally have three options to choose from for handling the account. I'll explain them, starting with the one that's best for most folks.

Option No. 1: Treat Inherited Account as Your Own
More often that not, you'll probably want to transfer your spouse's IRA (or SEP account) to your own name. By doing this, the IRS treats you as if you had always owned the account. Why is this a good thing? Well, for starters, if you are under age 70 1/2, this means you won't have to take any minimum withdrawals until after you hit that age, which offers you additional years of tax-deferred growth. And even if you are over age 70 1/2 this is a smart move, since you are allowed to use a longer joint life expectancy figure (vs. the single one you'd have to use if you leave the inherited account in your spouse's name). This means lower minimum withdrawal amounts and lower taxes.

Example 1:
Assume your husband passes away at age 67. You are 65 and the sole designated beneficiary of your husband's traditional IRA account. You then choose to treat the inherited account as your own. The easiest way to do this is to retitle the account to show you as the account owner (as opposed to the account beneficiary). And you should do so as soon as possible after your spouse dies. Treating the account as your own means no minimum withdrawals are required until after you turn 70 1/2, so the account's tax-deferral advantages can continue unabated until then.

Example 2:
Even if you are over 70 1/2, you come out ahead by transferring the account to your name. Assume you are older than your deceased spouse -- say, for example, you are 72 when your 66-year-old wife passes away -- and you are the sole beneficiary of her traditional IRA. In this case, you should leave the account in your wife's name until the year she would have turned 70 1/2.

Why? Because no minimum withdrawals are required during this period, so the account can continue to grow tax deferred. Once the year your wife would turn 70 1/2 is reached, you should then treat the account as your own by retitling it to show you as the account owner, rather than the account beneficiary. Then, take your initial minimum withdrawal by Dec. 31 of that year.

Option No. 2: Leave Account in Your Deceased Spouse's Name
Under this option, you simply leave the IRA (or SEP) account in your deceased spouse's name and begin taking minimum withdrawals when required. This is generally not the most tax-efficient way to handle the inherited account, but it's the simplest way. Keep in mind, however, that should you die, the beneficiary of the account will be the contingent second beneficiary that your late spouse designated. (You have no control over the beneficiary when you die, unless you treat the account as your own.)

What's the problem with this choice? Your annual minimum withdrawal calculations are made using your single life-expectancy figure as the divisor. In contrast, if you choose option No. 1 (above), you are allowed to use a longer joint life-expectancy figure. With option No. 2, you'll wind up with a lower divisor, higher minimum distribution amounts and more taxes. So if saving taxes is your goal, option No. 1 is clearly better.

If you nevertheless decide to use option No. 2, the first minimum withdrawal must be taken by the later of:

Your husband passed away in 2004, and he either turned 70 1/2 in 2004 or would have, had he lived. You are the sole designated beneficiary of his traditional IRA (or SEP) account. Under the rules just explained, you must take the initial minimum withdrawal from his account by the end of 2004. To calculate the proper amount you must first determine the appropriate life-expectancy divisor to use. And this depends on your age as of the end of 2004.

Let's say you'll be 68. Use Table I in Appendix C in IRS Publication 590 (Individual Retirement Arrangements) to find the single life-expectancy divisor for a 68 year old, which happens to be 18.6 years. Now divide the Dec. 31, 2003 account balance, say $250,000, by 18.6 to come up with your 2005 minimum withdrawal amount of $13,440. Take out that amount (or more) by the end of 2005 to avoid the 50% penalty. Your 2006 minimum withdrawal must be taken by the end of that year. The amount will equal the 2005 year-end account balance divided by 17.8 (the life expectancy divisor for a 69-year-old, per Table I). And so on for each subsequent year as long as you live.

Option No. 3: Follow the "Five-Year Rule"
Unless you want to completely drain the account, this is a stupid thing to do. With this option (assuming the IRA trust document permits it) you are allowed to do whatever you want with your deceased spouse's IRA (or SEP) account until Dec. 31 of the fifth year after the year your spouse dies. You can even leave the account completely untouched if you wish. However, by the end of that fifth year, you must completely drain the account and pay the resulting taxes. Ouch! As explained earlier, options No. 1 and 2 allow you to keep the inherited account open longer (usually much longer), which means more tax-deferral benefits for you. Really, the only good thing about option No. 3 is that you avoid being stung by the 50% penalty should you fail to follow the minimum withdrawal guidelines. Keep in mind, in some cases the IRA trust document requires (or the deceased spouse has specified) that the five-year rule must be used. In this case, there's little you can do other than follow the orders.