What Is an Extended IRA?
An Extended IRA allows a second-generation beneficiary to continue to distribute the assets over the life expectancy used by the first-generation beneficiary, thereby extending the IRA. Also known as a stretch IRA.
Understanding Extended IRAs
An individual who inherits IRA assets from the original IRA owner is referred to as the first-generation beneficiary. This individual is able to distribute the assets over his or her life expectancy or the remaining life expectancy of the original IRA owner. If the first-generation beneficiary subsequently dies, his or her designated beneficiary is the second-generation beneficiary.
This type of IRA is used by those who no longer need — or want — to take all of their IRA assets at the same time. Extended IRAs can have extensive tax benefits because second-generation beneficiaries are allowed to continue distributions over the life expectancy used by the first-generation beneficiary, thereby spreading the tax burden from distributions over a long period.
How the Second Generation Can Benefit
An individual retirement account is an investing tool used by individuals to earn and earmark funds for retirement savings. There are several types of IRAs as of 2020: Traditional IRAs, Roth IRAs, SIMPLE IRAs, and SEP IRAs. Sometimes referred to as individual retirement arrangements, IRAs can consist of a range of financial products such as stocks, bonds, or mutual funds.
With all of these investments, except the Roth IRA, pre-tax dollars are used to fund the account, up to certain limits. During the distribution phase, generally after age 59-1/2, the person who opened and funded the account must pay ordinary income taxes on any money withdrawn from the account. If the person who owns the account dies, taxes are still owed on the withdrawal of these assets even when the account is inherited by the first-generation beneficiary.
However, this first-generation beneficiary can spread out the taxes owed by taking distributions based on their life expectancy. Keep in mind that spouse and non-spouse beneficiaries are treated differently when it comes to IRAs. A spouse who inherits an IRA can either roll over the funds to their own IRA or wait to take Required Minimum Distributions (RMDs) until the late spouse would have been age 72.
Non-spouse beneficiaries have three choices, including taking an immediate payout of the full amount of the account and paying the IRS taxes. They can also begin taking RMDs based on their life expectancy or the life expectancy of the deceased; if they are over age 72, they must begin taking RMDs within a year of inheriting the IRA. Another option is to fully withdraw from the account over five years.
Required minimum distributions for traditional IRAs and 401(k)s have been suspended in 2020 due to the March 2020 passage of the CARES Act, a $2 trillion stimulus enacted amid the economic fallout from the COVID-19 pandemic.
The extended IRA is merely a provision that allows a second-generation beneficiary, and subsequent beneficiaries, to continue taking distributions based on the life expectancy of the first-generation beneficiary.