A Stretch IRA and How it Can Benefit You

A stretch IRA is an estate planning strategy that extends the life of an Individual Retirement Account (IRA) by allowing the original beneficiary to distribute the assets to a designated second generation beneficiary. This strategy allows the IRA to be passed on from generation to generation while extending its tax-deferred growth for years or decades beyond the life of the original account holder.

The term “stretch” does not represent a specific type of IRA; but instead is a financial strategy that allows people to stretch out the life and tax advantages of a traditional IRA.

Non-spousal individual beneficiaries of IRAs have three realistic options for receiving their inheritance:

1) Take a lump sum of the IRA’s balance. This causes the full value of the IRA to be included in the beneficiary’s income and taxed at the time of distribution.
2) Hold the funds in an “inherited IRA” subject to the 5 Year Rule. Non-spousal IRA beneficiaries have the choice to elect to withdraw all funds within an inherited IRA in a 5 year period. When this choice is made, the beneficiary does not need to make any minimum annual withdrawals as long as all funds are withdrawn prior to the 5 year deadline. This option is not available in all situations.
3) Hold the funds in an “inherited IRA” subject to the Life Expectancy Rules. This allows the beneficiary to “stretch” the IRA and spread out Required Minimum Distributions (RMDs) over his or her own life expectancy. The IRS requires non-spousal beneficiaries of inherited IRAs to start taking RMDs within a year of inheriting the IRA regardless of the beneficiary’s age. Those RMDs are based on the beneficiary’s life expectancy and calculated annually using an algorithm provided by the IRS (listed in the IRS’ “Uniform Lifetime” table). The younger the beneficiary, the lower the RMDs, and the longer the IRA can grow tax-free. Of course, a beneficiary of an inherited IRA can withdraw more than the annual minimum.

If the non-spousal beneficiary of an IRA is not an individual (i.e. it goes to an estate or a trust that doesn’t qualify as an individual), the beneficiary does not have the option to stretch the IRA. Not all IRAs allow you to take advantage of the stretch strategy. Investors should check with their provider or financial institution to see if this strategy is allowed.

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