Here's an idea that can keep on giving to children
and grandchildren long after the gift-giver, perhaps
you, has moved on to that great stock market in the
sky. It's called the Stretch IRA.
'Stretch' refers to setting up an IRA so that
required distributions, or withdrawals, may continue
for many years after the IRA owner has died. By
stretching out distributions, IRA beneficiaries may
build a tidy nest egg that could grow tax-free and
provide a regular source of income for decades.
The Stretch IRA benefits those who want to
preserve the account's tax-favored status when it is
transferred at death, who want to defer taxes as long
as possible, and who want to minimize taxes on
withdrawals. A Stretch IRA leaves more for heirs
and less for the IRS.
New rules that apply to tax-deferred retirement
accounts make it simpler and more beneficial to
stretch out distributions by increasing the amounts
that may be contributed and the time assets may
remain in these plans. These factors make the
Stretch IRA a particularly attractive approach to
building intergenerational family wealth.
One of the great things about the Stretch IRA is that
you don't have to give up anything (except a little
prep time) to get it. If a beneficiary needs to tap the
IRA account for additional funds beyond any year's
required minimum distribution, she may do so. Of
course, this will leave less in the account for later,
but she may continue to stretch out her distributions
over the full distribution period while there is money
remaining in the account.
Any type of IRA'the traditional IRA, the Roth
IRA, or the Simple IRA can become a Stretch
IRA. Even 401(k) or 403(b) accounts may either be
stretched (although few plans permit it) or converted
into Stretch IRAs.
First, a few important terms.
An IRA is an 'Individual Retirement
Arrangement.' IRAs have tax advantages that make
them attractive as long-term investment vehicles.
Those tax advantages are offset, however, by a few
disadvantages. One is that IRAs are taxed at higher
income tax rates. A second is that at certain times
the IRA owner or the owner's beneficiaries are
required to make withdrawals, or take distributions.
A beneficiary is any person or entity
the owner chooses to receive the benefits of the IRA
after he or she dies. Without naming one or more
human beneficiaries, the IRA may go to the owner's
estate and the full potential stretch could vanish.
Required minimum distributions (RMDs).
IRS does not permit funds to remain in retirement
accounts indefinitely. Eventually they must be
distributed, or withdrawn. The amount that must be
distributed each year to avoid severe tax penalties is
called the 'required minimum distribution.'
||Plan Value at Start of Year
||Required Minimum Distribution
||Federal Income Tax (35%)
||Cumulative Net Distribution
This example is provided for educational purposes only and does not represent actual results.
Refer to the Legal Disclosures and consult your advisor for more information.
Do The Right Thing
The stretch comes into play when the
IRA owner has named a beneficiary
and then dies. The beneficiary has
several options open to her. One is to
take the money and run?not a smart
move, as the entire amount will lose
its special tax-favored status and be
taxable at the beneficiary's income tax
rate. That, plus forgone tax-favored
gains, can devastate what may have
been a potential fortune.
An alternative is to stretch the required distributions
out for as long as possible. In this way the
inheritance retains its tax-deferred status and only
the distributions will be taxed at the beneficiary's
income tax rate unless it's a Roth IRA, in which
case the distributions will not be taxed at all! The
result is that the beneficiary can stretch out a taxdeferred
inheritance into a steady income stream for
much or all of his remaining life. The benefits could
be substantial, and the younger the beneficiary, the
greater the potential benefits.
Build Family Wealth
Suppose an IRA owner dies, leaving and IRA
balance of $1 million. Her beneficiary is her son,
who is age 50 when required to take minimum
distributions from the account. His RMD for the
first year on a $1 million IRA balance is $29,240.
Assuming that investments in the IRA account
return 8% a year and RMDs are taken at the end of
each year, the beneficiary's RMDs grow each year,
reaching $346,240 when he is 80 years old, with
cumulative after-tax distributions in excess of $2.5
million (refer to the table above). Should he live to
age 83, his required distribution would reach
$487,759, and at the end of the RMD period he
would have received cumulative after-tax
distributions of nearly $3.5 million.
Beneficiary are required to take minimum
distributions from Roth IRAs as well, but Roth IRAs
have an additional and highly significant benefit?
distributions are untaxed. Using the same
assumptions as before but with a Roth IRA, our
beneficiary could receive cumulative tax-free
distributions in excess of $5 million over 35 years.
With either IRA, the younger the beneficiary, the
greater the stretch and potential wealth creation.
The To-Do List
If you like this Stretch IRA idea, it may not happen
unless you act. Here's the first few steps.
- If you are or will be a beneficiary to someone's
IRA, the clock is ticking. Get assistance and get
educated. The choices you make now could mean
the difference between your financially
comfortable future and just a future.
- For every retirement plan that you own, name
beneficiaries and contingent beneficiaries. If you
did this awhile ago, check again to make sure
your ex-husband is not still listed as a beneficiary.
- For IRAs, choose beneficiaries who are likely to
appreciate and make use of the stretch. Taxable
assets are a better fit for those heirs who are likely
to tap their inheritances quickly.
- Most non-IRA plans [401(k)s, 403(b)s, etc.] do
not permit a stretch distribution. Owners of these
plans need to evaluate their options, including
converting plans to IRAs to enable the stretch.
- Educate your beneficiaries. Let them know that
you intend for them to stretch your IRA when
they inherit it. Show them (or have your advisor
show them) the benefits of the stretch and how
to do it.
- If the bulk of your wealth is in retirement plans
or if your estate is likely to be heavily taxed at
your death, get qualified help. There are ways to
reduce taxes and pass more on to your heirs.
- This whole area of naming beneficiaries and
complying with IRS regulations and retirement
plan rules is fraught with pitfalls, and policies are
ever-changing. Get a second and even a third
opinion to ensure that you have everything in
order. If you have special needs or considerations
not specifically addressed by the Stretch IRA, or
if your estate could be heavily taxed, discuss with
your advisors how to best address these issues.
In sum, the benefits of the Stretch IRA include:
- Taxes are deferred over the beneficiary's expected
- The beneficiary may accelerate distributions if
additional funds are needed.
- The distributions are taxed at the beneficiary's tax
bracket over his life expectancy.
- If estate taxes were paid on the IRA account, an
additional tax deduction that further reduces the
beneficiary's taxes on distributions is available.
- Should the beneficiary die before taking all his
RMDs, his heirs may continue to stretch out
distributions on his schedule.
If you truly care about your heirs, help them now to
make the most of their inheritance. If you care about
yourself, make the most of yours.