10 Most Frequently Asked Questions and Answers for Stretch IRAs

What is a stretch IRA?
Stretching an IRA is simply the ability to have an IRA live longer than the account owner. A stretch IRA is an IRA that uses beneficiary designations to enable assets to continue to grow tax deferred not only beyond the death of the original IRA owner; but even beyond the death of his or her beneficiaries. Until recently, IRA assets were usually liquidated shortly after the beneficiary’s death. This put an end to tax deferral and often resulted in large taxable distributions. Thanks to a private letter ruling by the IRS, you can avoid immediate liquidation and extend the life of the IRA because beneficiaries are now allowed to make the required distributions from the IRA over their own life expectancy.The required minimum distributions are calculated each year simply by dividing the account value at the beginning of the year by the applicable life expectancy factor of the beneficiary for that year.By naming your children or grandchildren as beneficiaries, the applicable life expectancy factors are greater resulting in smaller annual required distributions.This allows IRA assets to be passed along the family tree, allowing tax deferral to continue for other generations

What are the benefits of stretching-out an IRA?
By “stretching-out” an IRA, you are maximizing the life of an investment and extending the deferral of taxes on the assets held in it. Stretching out an IRA extends its tax deferred growth for the lifetime of the beneficiaries resulting in substantially more growth than if the IRA were paid out immediately following the original owner’s death.
These features make the IRA one of the best investment alternatives for transferring assets to your children and grandchildren.

If a beneficiary of an IRA dies, can that beneficiary’s beneficiary now recalculate required minimum distributions (RMDs) based on their own life expectancy?
No. RMDs to the beneficiary’s beneficiary must continue over the same period based on the same calculation method as RMDs to the original beneficiary. In order to increase the “stretch-out”, name your grandchildren as the beneficiaries of your IRA.
This will decrease the RMD amount because your grandchild’s life expectancy is used to calculate this amount. This is the most effective way to increase the potential for tax deferred growth.
For example, a 5 year old, according to the IRS, has a life expectancy of 76.6 years, which results in an RMD of only 1.3% of the account value. In contrast, a 45 year old has a life expectancy of 37.7 years which results in an RMD of 2.65%, over twice the required distribution for a 5 year old.
Taking smaller distributions leaves more money in the IRA to grow. Consequently, the younger the beneficiary, the greater the stretch.

Does a stretch-out IRA allow an IRA owner’s child to roll over the IRA into their name?

No. Technically, your IRA remains your account as the original owner, even after your death. In order for the stretch to work, the beneficiary must maintain the IRA in the deceased’s name. The only person who can treat a deceased’s IRA as their own is the deceased’s spouse. Only a spouse can roll the IRA into their own IRA account. A non-spouse would base the required distributions on their own life expectancy as stated in the IRS life expectancy tables. This calculation sets up an income stream over a set number of years. The final stage in the stretch involves the ability of a beneficiary to name their own beneficiary. Upon the death of the original beneficiary, the new beneficiary is allowed to continue the income stream previously established. By taking advantage of these options, an IRA can last for decades after the death of the original owner and generate hundreds of thousands of dollars. For example, a $100,000 balance in a 401(k) that a 60 year old retiree with a 58 year old spouse rolls over to an IRA with their 35 year old children as contingent beneficiaries results in dramatic consequences for the wealth of the entire family. Assuming a 12% annual rate of growth and average life expectancies for this couple, taking out only RMDs results in distributions totaling over $470,000 to them and over $5.1 million to their children over their lifetime.

Who can establish a stretch IRA?

Any IRA owner may create a stretch IRA through proper designation of beneficiaries. These beneficiaries must be established prior to death. Establishing primary and contingent beneficiaries on every IRA account is of the utmost importance. The stretch out option give investors greater control over their IRAs and the ability to maximize tax deferral. This can keep an inheritance growing for a longer period of time and can ensure ongoing financial security for one’s heirs.

Does the stretch concept apply to qualified plans such as 401(k)s and other company sponsored plans?

Not Usually. Unlike IRAs, the beneficiary options for qualified plans are plan-specific. No company is going to deal with the administrative headache of distributing between 1% and 5% of the account value over the next 60 years to a 5 year old beneficiary, who inherits an account. Consequently, it is imperative that any 401(k) or other employer retirement plan be rolled over to an IRA in order to preserve the ability to stretch out distributions to beneficiaries over the maximum length of time

Who can I name as a beneficiary of my IRA to accomplish this stretch out option?

Your can name anybody as your IRA beneficiary and you can change your beneficiaries at any time. Typically, your beneficiary is going to be either your spouse, a non-spouse or a trust. As a practical measure, naming your spouse as your primary beneficiary ensures that the IRA is available to help meet their income needs. Upon death, a spousal beneficiary assumes ownership of the IRA and can then name their own beneficiaries. If your spouse has sufficient assets or has predeceased you, a non-spouse beneficiary, such as your children or grandchildren, may be named. In choosing such beneficiaries, one should consider their income needs, marginal tax rates and age. If your children don’t need the additional income that a beneficiary IRA provides, naming your grandchildren as beneficiaries increases the stretching of that IRA due to their longer life expectancy. Since the required distributions are smaller, the taxes payable on the distributions are also smaller. Naming a trust as a beneficiary helps to control what happens to your IRA after your death.

If multiple beneficiaries are named on a Traditional IRA, does each beneficiary have the same stretch options?

Yes. Each beneficiary may establish a separate beneficiary IRA whereby RMDs are calculated based upon each individual beneficiary’s life expectancy. Beneficiary IRAs prevent assets from becoming fully taxable by ensuring that the assets are not placed in the beneficiary’s name. To maximize tax-deferred growth, a non-spouse beneficiary must maintain the IRA in the deceased’s name.

If the beneficiary of an IRA is a trust, can the stretch option still be utilized?

The stretch option may be utilized if the trust is named as the designated beneficiary, clearly names beneficiaries and becomes irrevocable upon the death of the IRA owner. Nelson Investment Planning Services has created a prototype IRA Trust Agreement to accomplish the stretch. This trust provides an IRA owner the ability to protect their family and control distributions. Naming individual beneficiaries may defeat your intention to have the asset extended over the longest possible time. By law, your beneficiary can do whatever they want with the assets – including liquidating the IRA completely – regardless of your plans. An IRA Trust ensures that your desires are fully carried out.

Can I change my distributions?

Of course. At any time, if the owner or beneficiary’s situation changes, the amount of distributions from an IRA can be increased above the RMD amount. If an owner or beneficiary of an IRA needs income or requires a lump sum distribution of any amount, then such distributions can be made at any time. The RMD amounts are just that – the minimum amount that must be distributed. Stretching out an IRA does not limit your ability to withdraw money from the IRA. In addition, since payments to beneficiaries are paid out as death distributions, there is no 10% penalty that would normally apply for premature distributions before age 59 ½. Of course, income tax rates apply to every dollar withdrawn at the recipient’s marginal tax rate.