The term “stretch IRA” has become a popular way to refer to an IRA (either traditional or Roth) with provisions that make it easier to “stretch out” the time period that funds can stay in your IRA after your death, even over several generations. It’s not a special IRA, and there’s nothing dramatic about this “stretch” language. Any IRA can include stretch provisions, but not all do.
Why is “stretching” important?
Any earnings in an IRA grow tax deferred. Over time, this tax-deferred growth can help you accumulate significant retirement funds. If you’re able to support yourself in retirement without the need to tap into your IRA, you may want to continue this tax-deferred growth for as long as possible. In fact, you may want your heirs to benefit–to the greatest extent possible–from this tax-deferred growth as well.
But funds can’t stay in your IRA forever. Required minimum distribution (RMD) rules will apply after your death (for traditional IRAs, minimum distributions are also required during your lifetime after age 70½).
The goal of a stretch IRA is to make sure your beneficiary can take distributions over the maximum period the RMD rules allow. You’ll want to check your IRA custodial or trust agreement carefully to make sure that it contains the following important stretch provisions.
Key stretch provision #1
The RMD rules let your beneficiary take distributions from an inherited IRA over a fixed period of time, based on your beneficiary’s life expectancy. For example, if your beneficiary is age 20 in the year following your death, he or she can take payments over 63 additional years (special rules apply to spousal beneficiaries). As you can see, this rule can keep your IRA funds growing tax deferred for a very long time.
But even though the RMD rules allow your beneficiary to “stretch out” payments over his or her life expectancy, your particular IRA may not. For example, your IRA might require your beneficiary to take a lump-sum payment, or receive payments within 5 years after your death. If stretching payments out over time is important to you, make sure your IRA contract lets your beneficiary take payments over his or her life expectancy.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2013
Key stretch provision #2
What happens if your beneficiary elects to take distributions over his or her life expectancy but dies a few years later, with funds still in the inherited IRA? This is where the IRA language becomes crucial.
If, as is commonly the case, the IRA language doesn’t address what happens when your beneficiary dies, then the IRA balance is typically paid to your beneficiary’s estate.
However, IRA providers are increasingly allowing an original beneficiary to name a successor beneficiary. In this case, when your original beneficiary dies, the successor beneficiary “steps into the shoes” of your original beneficiary and can continue to take RMDs over the original beneficiary’s remaining distribution schedule. When reviewing your IRA language, it’s important to understand that a successor beneficiary is not the same as a contingent beneficiary. Most IRA providers allow you to name a contingent beneficiary. Your contingent beneficiary becomes entitled to your IRA proceeds only if your original beneficiary dies before you.
Stretch even further …
If you name your spouse as beneficiary, your IRA can stretch even further. This is because your spouse can elect to treat your IRA as his or her own, or to transfer the IRA assets to his or her own IRA. Your spouse then becomes the owner of your IRA, rather than a beneficiary. As owner, your spouse won’t have to start taking distributions from your traditional IRA until he or she reaches age 70½ (and no lifetime RMDs are required from your Roth IRA). Plus, your spouse can name a new beneficiary to continue receiving payments after he or she dies.
What if your IRA doesn’t stretch?
If your IRA doesn’t contain the appropriate stretch provisions, don’t fret–you can always transfer your funds to an IRA that contains the desired language. In addition, upon your death, your beneficiary can transfer the IRA funds (in your name) directly to another IRA that has the appropriate stretch language.
A word of caution
While you might appreciate the value of tax-deferred growth, your beneficiary might prefer instant gratification. If so, there’s little to prevent your beneficiary from simply taking a lump-sum distribution upon inheriting the IRA, rather than “stretching out” distributions over his or her life expectancy. It’s possible, though, to name a trust as the beneficiary of your IRA to establish some control over how distributions will be taken after your death.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The tax information provided is not intended to be a substitute for specific individualized tax planning advice. I suggest that you consult with a qualified tax advisor.