The "stretch IRA" is not a new IRA account on the market or even a new investment concept. It is a wealth transfer method that allows you the potential to "stretch" your IRA over several future generations. As an IRA owner, you are typically required to take minimum distributions from your IRA starting at age 70.5 based on an IRS life expectancy table. If you are fortunate enough to inherit someone else's IRA, you will be required to take minimum distributions each year from the IRA account based on your life expectancy figure regardless of your age.
IRA accounts pass at the death of the owner by contract or beneficiary designation. It is typical practice for most IRA owners to name their spouse as the primary IRA beneficiary and their children as the contingent beneficiaries. While there is nothing wrong with this strategy, it might require the spouse to take more taxable income from the IRA than what they really need when they inherit the IRA. If income needs are not an issue for the spouse and children, then naming younger beneficiaries (such as grandchildren or great-grandchildren) allows you to stretch the value of the IRA out over generations. This is possible because grandchildren are younger and their required minimum distribution (RMD) figure will be much less at a younger age (see example below).
Traditional IRA worth $500,000 on 12/31/2009
Owner: Dave (deceased 12/1/2009); *IRA Inherited by:
a) Spouse: Mary (Age 73 in 2010)- Mary will have to take an RMD of $20,234 in the year 2010
b) Son: Mike (Age 55 in 2010)- Mike will have to take an RMD of $16,892 in the year 2010
c) Granddaughter: Julia (Age 28 in 2010)- Julia will have to take an RMD of $9,042 in the year 2010
d) Great Grandson: Dallas (Age 6 in 2010)- Dallas will have to take an RMD of $6,519 in the year 2010
*Each beneficiary will have to continue to take the RMD each year thereafter based on the new life expectancy figure that must be computed each year from the IRS Publication 590 (IRAs) from the Appendix B-Life Expectancy Tables section.
If Dave is careful in the beneficiary selection, the younger the beneficiary the less the RMD payment. This allows the IRA value to continue to grow tax-deferred, thus allowing it to stretch to several generations.
Find out how your beneficiaries can enjoy tax-deferred growth for as long as possible by referring to Want to Leave Money to Your Family? Stretch Your IRA.
Jack Brkich III, CFP®
JMB Financial Managers, Irvine, CA
A stretch IRA is most commonly used by individuals who aren’t in need of the extra income or who plan to pass on a legacy to heirs in a tax-efficient fashion. These are the pros:
- They potentially provide a lifetime of income to a beneficiary.
- The total tax paid may be lessened due to taking smaller distributions over an extended period of time rather than as a single lump-sum.
- Extending the period of time in which distributions are made lengthens the time in which assets have to grow tax-free and increases the amount beneficiaries receive.
These are the cons:
- A beneficiary may not live a normal life expectancy.
- Changes in laws or regulations could have detrimental effects on the owner or beneficiaries.
- Like any investment, losses or inflation could eat into the value of future distributions.