A stretch IRA is a traditional IRA that passes from the account owner to a younger beneficiary 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 will be able to “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.
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 expectancies. 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 then-current income tax rates.
It’s worth noting that beneficiaries also 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.
If you do not currently have any IRA beneficiaries, employing the stretch technique by naming a (human) beneficiary could provide significant long-term benefits. Special rules apply to naming a trust or estate as IRA beneficiaries, so it’s best to consult a tax or financial planner to discuss the consequences and pitfalls.
Your enhanced ability to stretch IRA assets is a direct result of an IRS decision to simplify the rules regarding RMDs from IRAs. The 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). Also, 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 rules presented in this article apply to traditional IRAs bequeathed to a non-spousal beneficiary. Special rules apply to spousal beneficiaries.
So if you’re unlikely to deplete your IRA assets during your lifetime, consider creating a multi-generational stretch IRA. By doing so, you could build long-term financial security for a loved one while minimizing estate taxes.
If you would like to review your current beneficiary designations or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.
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