The Stretch IRA: A Handy Estate-Planning Tool
A picture-perfect retirement doesn’t just happen – it requires careful planning, saving and investing to come to fruition. But imagine you spend years stocking up money in your traditional IRA, only to pass away before you can cash in on that money?
As unfortunate as this is, it happens fairly often. Instead of directly bequeathing your retirement funds to heirs, you might opt for a Stretch IRA. Let’s explore what a Stretch IRA is and how it could benefit your loved ones in the event that you are unable to do so yourself.
What is a Stretch IRA?
A stretch IRA is a traditional IRA that passes from the account owner to one or more younger beneficiaries at the time of the account owner’s death.
Since the younger beneficiary has a longer life expectancy than the original IRA owner, he or she can “stretch” the life of the IRA by receiving smaller required minimum distributions (RMDs) each year over his or her life span. More money can then remain in the IRA with the potential for continued tax-deferred growth, which could provide significant long-term benefits.
The Nitty Gritty on Stretch IRAs
Creating a stretch IRA has no effect on the account owner’s RMD requirements, which continue to be based on his or her life expectancy. Once the account owner dies, however, beneficiaries begin taking RMDs based on their own life expectancy.
Whereas the owner of a stretch IRA must begin receiving RMDs after reaching age 70 1/2, beneficiaries of a stretch IRA begin receiving RMDs after the account owner’s death. In either scenario, distributions are taxable to the payee at current income tax rates.
Beneficiaries have the right to receive the full value of their inherited IRA assets by the end of the fifth year following the year of the account owner’s death. However, by opting to take only the required minimum amount instead, a beneficiary can theoretically stretch the IRA and tax-deferred growth throughout his or her lifetime.
Other key considerations
- New rules allow beneficiaries to be named after the account owner’s RMDs have begun, and beneficiary designations can be changed after the account owner’s death (although no new beneficiaries can be named at that point).
- The amount of a beneficiary’s RMD is based on his or her own life expectancy, even if the original account owner’s RMDs had already begun.
Note that the information presented here applies to traditional IRAs bequeathed to a non-spousal beneficiary. Special rules apply to spousal beneficiaries when it comes to your retirement plan – it’s best to contact your financial advisor or tax professional for more information.
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