By Randy Neumann
Can an IRA keep growing for a century or more? In theory, it can. Some people are planning to “stretch” their Individual Retirement Accounts over generations, so that their heirs can receive IRA assets accumulated after decades of tax-deferred or tax-free growth. A stretch IRA can potentially create a legacy of wealth to benefit your heirs, and it could also help to reduce your estate taxes.
Usually, this is done by “people of means.” Typically, an individual, couple or family has amassed sizable retirement savings – so sizable that they don’t need to withdraw the bulk of their IRA assets during their lifetimes. However, this is not always the case, it can be done by anyone who doesn’t need income from their IRA. So, how does this work? Simply put, a stretch IRA is a Roth or traditional IRA with assets that pass from the original owner to a younger beneficiary when the original account owner dies. The beneficiary can be a spouse, a non-spousal heir or a “seethrough” trust.
If the beneficiary is a person, this younger beneficiary will have a longer life expectancy than the initial IRA owner, and therefore may elect to “stretch” the IRA by receiving smaller required minimum distributions (RMDs) each year of his or her life span. This will leave money in the IRA and permit ongoing taxdeferred growth – or tax-free growth, in the case of a Roth IRA.
In fact, since you don’t have to take RMDs from a Roth IRA at age 70+, you could opt to let your Roth IRA grow untapped for a lifetime. At your death, your beneficiaries could then stretch payouts over their life expectancies without having to pay tax on withdrawals. What a deal!
Okay, what options do your beneficiaries have after your death? If truth be told, the rules governing inherited IRAs are quite complex. The explanation below is simply a summary, and should not be taken as any kind of advice or guidance. (Be sure to discuss any tax or legal matters with the appropriate professional.)
If you have named your spouse as the beneficiary of your IRA, your spouse can roll over the inherited IRA assets into his or her own IRA after your death. Only a spouse can treat an IRA as if it were their own after your death. This holds some advantages such as: taking RMDs at their own age, not yours, as with other beneficiaries and gives them the ability to create a new “stretch” IRA at their death.
In the case of a non-spousal beneficiary, he or she cannot treat the IRA as his or her own, and cannot make contributions to it or rollovers into or out of it. A non-spousal beneficiary can either take the lump sum and pay taxes on it, or transfer the IRA assets to an IRA distribution account that they can then “stretch.”
Under the one-year rule, annual distributions are based on the life expectancy of the designated beneficiary and must start by December 31 of the year following the original IRA owner’s death. In this way, your beneficiary can stretch out the distributions over his or her life expectancy, which can allow more of the inherited IRA assets to remain in the IRA and enjoy tax-deferred or tax-free growth.
Under the five-year rule, there are no minimum annual distribution requirements, but the beneficiary must withdraw their full interest by the end of the fifth year following the owner’s death.
The beneficiary can be determined even after the original IRA owner dies. If by chance there is no named beneficiary, you have until the end of the year following the death of the primary IRA owner to establish one. But don’t let this happen. It is vital to establish a beneficiary during your lifetime: if you don’t, your IRA assets could end up in your estate, and that will leave your heirs with two choices. If you pass away after age 70+, the RMDs from the IRA are calculated according to what would have been your remaining life expectancy. If you pass away before age 70+, the five-year rule applies: Your heirs have to cash out the entire IRA by the end of the fifth year following the year of your death!
In closing, here are a few things to think about:
The decision to stretch your IRA cannot be made casually. A beneficiary must be selected with great care, and there is always the possibility that you may end up withdrawing all of your IRA assets during your lifetime. A stretch IRA strategy assumes that your beneficiary won’t deplete the IRA assets, and it also assumes a constant rate of return for the account over the years. It’s also worth remembering that stretch IRA planning is based on today’s tax laws, not the tax laws of tomorrow.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann, CFP® is a registered representative with and securities and insurance offered through LPL Financial. Member FINRA/ SIPC. He can be reached at 600 East Crescent Avenue, Suite 104, Upper Saddle River, NJ 07458, 201-291-9000.