When you go to open an IRA account you will probably find that there are several variations. One variation of an individual retirement account (IRA) is a stretch IRA. This concept is used to pass the proceeds from an IRA to younger generations rather than to your spouse or peers. IRA owners must begin receiving distributions by the age of 70 and ½. The distributions are based on the life expectancy of the owner. Older owners will have a greater required minimum distribution (RMD) while younger owners will have a much smaller RMD.
Comparing the RMD of a retiree who is 73 years old, versus the grandchild of an individual with a stretch IRA, you will see how the money saved in the original IRA could potentially last two or more lifetimes. A good example is looking at how a $500,000 IRA would be distributed. The original owner would be required to take a minimum distribution of a little over $20,000. If this same IRA was inherited by a child, and that child was 55 years old, their minimum distribution would be around $17,000. If instead of a child, it was a 28 year old grandchild that inherited the IRA, they would have to take a minimum distribution of approximately $9000. If the grandchild was only 6 years old, that distribution would be around $7000 per year.
The amount of the distributions is based on the IRS Single Life Expectancy Table. Potentially, depending on the amount accumulated in the IRA and the lifespan of the beneficiaries, the stretch IRA could span several generations. If the stretch IRA is a traditional IRA or a Roth IRA both will benefit from tax deferred growth even if the distributions are being directed to a beneficiary. Traditional IRA distributions will be taxed as ordinary income and Roth distributions are usually tax free.
This product has the capacity of passing on supplemental income that grows tax deferred to future generations, stretching the IRA’s proceeds significantly. This is especially true if the rate of growth for the IRA is consistent year after year and decade after decade. It also opens up a new means of passing on one’s wealth without the dealing with the burdensome process of probate and the estate taxes associated with probate.
8 responses to “Take Advantage of a Stretch IRA”
Stretch distributions are a very good technique but care must be exercised. Remember the beneficiary has control and they can accelerate these payments or take a lump sum. Many of my clients considering this opt for naming a trust as a beneficiary rather than the grandchild directly. This needs to be carefully discussed with an estate planning attorney to get this right and to see if it fits into a person’s overall income and estate plan.
While good estate tax planning is essential to all wealth management, this is especially true for taking full advantage of an IRA’s potential.
And yet, this is one of the topics addressed in POTUS’ budget, getting rid of the stretch. An inherited IRA would have a five year life, and at the end of five years all assets must be distributed if they are still in the account. Too bad.
On the spousal inheritance – yes, a spouse can move the IRA into her own name and treat it accordingly. But, if she is young enough, she might be better off keeping it as a beneficiary IRA. Yes, there’s an RMD each year, but she can also withdraw more than that. Tax due (to the extent this money is pretax) but no penalty. If she puts it in her name, any withdrawals have a 10% penalty. By ‘young enough’ I meant under 59-1/2 and needing to start withdrawals soon. Obviously, a 58 year old might wait, but a gal in her 40’s might like the flexibility.
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I have a question.
You write “It also opens up a new means of passing on one’s wealth without the dealing with the burdensome process of probate and the estate taxes associated with probate.” I thought that IRAs (and presumably 401ks 403bs etc) are part of the estate for estate tax purposes even though the IRAs themselves (and their corresponding income tax obligations) are passed on to the beneficiaries by the IRA custodian and not as a disbursement from the executor of the will? For example, at http://www.unclefed.com/AuthorsRow/TaxBusProf/ira.html it specifically says ” On the death of the IRA owner, the IRA faces a potential tax double-hit. First, as a general rule, the value of the account is includable in the person’s taxable estate for estate tax purposes. Second, payments from the IRA to other beneficiaries are subject to income taxes, ……” Has the law changed so that the first sentence from unclefed is no longer applicable?
When your beneficiary inherits your IRA, he or she might also have the ability to take required minimum distributions (RMDs) based on his or her life expectancy. (RMDs are calculated each year and must begin no later than December 31 of the year following your death.) In this way, your beneficiary would have the potential to stretch the distributions over his or her own lifetime, which enables the funds to continue compounding tax deferred for a longer period and avoids a large initial tax bill. Your beneficiary can also name a beneficiary, who can potentially stretch the distributions even longer.