How to Stretch an IRA For Your Beneficiaries


Can an IRA keep growing for a century or more?  Some people are planning to stretch their individual retirement accounts over generations so that their heirs can receive IRA assets accumulated after decades of tax deferred or tax free growth. A stretch can potentially create a legacy of wealth to benefit your heirs, it can also help you to reduce your estate taxes. Usually this is a choice of the high net worth investor, but can also apply to baby boomers as well. Typically, an individual, couple, or family, has a sizeable retirement savings, so sizable that they don’t need to withdrawal the bulk of their IRA assets during their lifetime.

How Do Stretch IRA’s Work?

Simply put, a stretch IRA is a Roth or traditional IRA account with assets that pass from an original account owner to a younger beneficiary, when the original account owner dies. The beneficiary can be a spouse or a non-spousal heir. If the beneficiary is a person, this younger beneficiary will have a longer life expectancy than the initial IRA owner, and therefore may elect to stretch the IRA by receiving smaller, required minimum distributions each year of his or her life span. This will leave money in the IRA and permit ongoing tax deferred growth or tax free growth in the case of the Roth IRA. In fact, you don’t have to take RMDs from a Roth IRA at age 70.5. You can also let your Roth IRA account grow on tap for a lifetime. At your death your beneficiaries could then stretch pay outs over life expectancies without having to pay tax on withdrawals.

Beneficiary Options for Stretch IRA’s

Well, the rules governing inherited IRAs are quite complex. The explanation below is simply a summary action and should not be taken as any kind of advice or guide. If you have named your spouse as a beneficiary of your IRA, your spouse can rollover the inherited IRA assets into his or her own IRA after your death. If you die before age 70.5, your spouse can treat the inherited IRA as his or her own and make contributions and withdrawals or instead of treating the IRA as his or her own, your spouse can elect to begin receiving distributions on either December 31 of the calendar year following your death, or the dates that you would have been age 70.5, whichever date is later.

If your beneficiary is not thoughtful, he or she cannot treat the IRA as his or her own, and cannot make contributions to it, or rollovers into or out of it. Any non-spousal beneficiary can either take the lump sum and pay taxes on it, or transfer the IRA assets to an IRA distribution account. If your non-spousal beneficiary elects to set up a distribution account, and you have passed away before age 70.5, he or she must follow either the one year rule, or the five year rule. Under the one year rule, annual distributions are based on the life expectancy of the designated beneficiary, and must start by December 31st of the year following the original IRA owner death. This way, your beneficiary can stretch out the distributions over his or her life expectancy, which can allow more of the inherited IRA assets to remain in the IRA and enjoy tax deferred or tax free growth.

Five Year Rule

Under the five year rule, there are no minimum annual distribution requirements, but the beneficiary must withdraw their full interest by the end of the fifth year following the owner’s death. The beneficiary can be determined, even after the original IRA owner dies, if there is somehow no named beneficiary, you have until the end of the year following the death of the primary IRA owner to established one. But, it is vital to establish a beneficiary during your lifetime. If you don’t, your IRA assets could end up in your estate, and that will leave your heirs with two choices. If you pass away after age 70.5, the RMDs and IRA are calculated according to what it would have been your remaining life expectancy. If you pass away before age 70 and a half, the five year rule applies. Your heirs have to catch up the entire IRA by the end of the fifth year, following the year after death.

Since the stretch IRA cannot be made casually, a beneficiary must be selected with great care, and there’s always the possibility that you may end up withdrawing all of your IRA assets during your lifetime. A stretch IRA strategy assumes that your beneficiary won’t deplete the IRA assets. It also assumes a constant rate of return for the account over the years. It’s also worth remembering that stretch IRA planning is based on today’s tax laws, not the tax laws of tomorrow.

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