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Stretching Your IRA to the Next Generation

It’s no secret that retirement accounts come in all shapes and sizes … from the account that is strictly set aside to generate retirement income to an account earmarked for heirs. For those intending to bequeath their individual retirement account funds to survivors, a change in Internal Revenue Service regulations in January of 2001 (followed by an April 2002 revision) created a wealth-transfer strategy that actually allows for the tax benefits of an IRA to be “stretched” beyond the lifetime of the person who established the IRA.

In the past, IRS law had required non-spouse beneficiaries to completely withdraw IRA assets either within five years of the originator’s death or heretofore remaining life expectancy. The stretch IRA allows for the IRA to be passed down several generations over the life expectancies of non-spousal beneficiaries like grandchildren, great-nieces, nephews and others.

The biggest advantage to establishing the stretch IRA is its earning power. The smaller required minimum distributions to younger, non-spouse beneficiaries and the extended time for the investments in IRAs to grow at a compounded, tax-deferred rate allow for the payouts to substantially increase. For example, at an 8 percent annual return, $100,000 inherited by a 20-year-old could translate into distributions totaling $2.9 million during the course of the beneficiary’s life expectancy.

Financial institutions should be aware of the stretch IRA for customers for whom it is applicable. It has been around for a while but, surprisingly, it’s not being utilized as much as it could be. To make it work, encourage clients to work with estate planning attorneys who have stayed current with these laws.

There are some rather tricky areas in terms of structuring the stretch IRA. For example it is imperative that the IRA remain in the name of the original holder for non-spouse beneficiaries to avoid tax consequences. They cannot simply roll it into their own IRA without tax implications.

“Look-through trust options” add additional flexibility and control for stretch IRAs. There are two effective trust dispositive provisions that “stretch” distributions. The “option” method allows the named beneficiary the option of choosing the amount and timing of the distribution of IRA assets over and above the annual required minimum distribution. The “trustee discretion” method allows for the trustee to distribute additional amounts if the trustee deems advisable in terms of health, education, support and welfare.

Stretch IRAs enhance the element of control a holder can exercise over the disposition of retirement assets. There is no down side for incorporating a stretch IRA into one’s financial plan, and the upside can provide ongoing income for several generations.