DEFINITION of 'Stretch IRA'
An estate planning concept that is applied to extend the financial life of an Individual Retirement Account (IRA) across multiple generations. A stretch IRA strategy allows the original beneficiary of an IRA to distribute assets to a designated second-generation beneficiary, or even a third- or fourth-generation (or more) beneficiary. By using this strategy, the IRA can be passed on from generation to generation while beneficiaries enjoy tax-deferred and/or tax-free growth as long as possible. The term "stretch" does not represent a specific type of IRA; rather it is a financial strategy that allows people to stretch out the life – and therefore the tax advantages – of an IRA.
BREAKING DOWN 'Stretch IRA'
Stretching out an IRA gives the funds in the IRA more time – potentially decades – to compound tax-deferred. This provides the opportunity to grow the funds significantly for future generations. With a traditional IRA, the owner has to begin taking the required minimum distribution (RMD) by April 1 of the year after turning 70.5. The RMD is calculated by taking the account balance on December 31 of the previous year, and dividing that number by the number of years left in the owner's life expectancy (as listed in the IRS' "Uniform Lifetime" table.) Each year, the RMD is calculated by dividing the account balance by the remaining life expectancy.
Non-spousal heirs of any age, regardless of the type of IRA, must take RMDs based on their life expectancy. The younger the beneficiary, the lower the RMD, which allows more funds to remain in the IRA to stretch the IRA over time.
However, not all IRAs allow the stretch strategy, and investors should check with their provider or financial institution to determine if beneficiaries will be allowed to take distributions over a life-expectancy period.